As we settle into 2018, I’ve been giving some consideration to valuation. Specifically, what we can expect for the year ahead. Having now had the opportunity to review the returns obtained by fellow investors it seems clear 2017 was a very good year indeed. My 42.72% return, as outlined here, was, for me, exceptional and unlikely to be matched this year.
But with such a large run-up last year, are equities expensive? Are we, dare I say it, approaching a bubble?
Beginning with the CAPE ratio for the UK, the excellent data source Starcapital.de has the UK as a whole at a CAPE ratio of approximately 15.7. The FTSE All Share is a little higher at 17.3. Whilst this isn’t defined as ‘cheap’, it certainly is towards the ‘cheaper’ end of the CAPE scale. In fact, it is the 13th cheapest country listed on their site. Compared to the long-term average of around 15-16, this would suggest the UK is, at worst, fairly valued. I would suggest you read the excellent valuations from John Kingham of both the FTSE 100 and the FTSE 250.
Nick Kirrage has an excellent chart on Cityam.com which compares current valuations to past peaks. The current CAPE ratio is reasonably low compared to previous market highs:
I don’t see much irrationality at the moment. When I think back to the 70’s, and the view regarding the high quality “nifty fifty” growth stocks, we’re nowhere near that. The suggestion was that buying and holding these quality, growing companies was worth it at any price. Unfortunately, this meant paying for Polaroid at 91 times earnings, Disney at 82 and McDonalds at 86. As it turns out, doing exactly that actually worked out in some instances. Unfortunately it most definitely did not in others.
The point is, growth at any price should be avoided. And I see little evidence of that mentality as a whole at the moment. Some of the traditional large cap, quality companies aren’t trading on ridiculous valuations. For example, Unilever trades at 23 times earnings. British American Tobacco, 22x and Reckitt Benckiser, 23x.
Even smaller cap, faster growing companies are, by and large, reasonably priced. Bioventix, for example trades at 26x, XL Media, 22x and Somero Enterprises 15x. Every company listed here posts five year average returns on investment of over 15%.
We’re not paying any price for growth, yet.
I heard something interesting on the awesome new podcast Animal Spirits hosted by Michael Batnick & Ben Carlson. They mentioned that equities are largely being bought because people are seeking a return they can’t get anywhere else. This made me think about Bitcoin and the attitude towards that versus stocks. The US markets are expensive, this seems apparent, but I’m not sure people are necessarily buying equities anywhere just to get in on the ride.
It appears largely impossible to ‘value’ Bitcoin, and yet people are buying at a frantic pace. The pure hope is that the price goes up, so that they can sell and make money. Therein lies the difference. People (largely) buy equities in the expectation that they will continue to perform and increase in value. People (largely) are buying Bitcoin in the hope it goes up in price.
The nifty-fifty and the dot-com bubble gave rise to unsustainable valuations because they were supposedly worth it at any price. This has since been proven to have been fallacious.
I’d be interested to hear your opinions, but for me I think now is a good time to be buying equities. Let me know your thoughts.
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Somero Enterprises is a constituent of the portfolio.