Posted by: Aaron Pressman on December 18, 2007
You often hear a stock or an index or even a whole market castigated as “overvalued” because it appears to be trading at a high level relative to earnings. In all but the most extreme cases, though, the simple price-to-earnings ratio doesn’t tell you enough to make an informed investment decision. Thus, some analysts go a step further and compare a P/E ratio to a company’s expected rate of earnings growth. This is known as the PEG ratio. A company with a high P/E ratio and a high rate of future growth is likely to be a better deal than a company with a slightly lower P/E but a much lower growth rate. That’s a proposition that has been proven over time, as in this study by the Motley Fool web site, for example.
Now the good fellows at Bespoke Investment Group are extending the useful PEG ratio into the realm of international markets. They’ve taken all 22 countries with U.S.-listed exchange-traded funds and compared market P/E ratios to the growth of those countries’ economies. China’s market, for example, trades at a seemingly steep 45 times earnings but with growth of over 11%, its PEG ratio of just under 4 is decidedly middle of the road. Meanwhile, Italy’s stock market trades at a P/E of just over 14 but with growth of under 2% that’s a PEG of over 7, worst of all except Japan. By this measure, the three best opportunities look to be Malaysia with a PEG ratio of 2.32, Russia at 1.71 and topping the charts is Singapore at 1.43.
Now there are a few obvious caveats despite the pretty data. First, Bespoke hasn’t gone back and tested whether its new international PEG ratio has any predictive value. We’ll have to revisit that question down the road. Second, the PEG ratios you see quoted on individual U.S. stocks typically use estimates of future earnings growth. Bespoke used GDP growth over the past year. Finally, at least with individual stocks, screaming bargains aren’t obvious until a PEG ratio sinks below 1 and none of the international markets sits that low.