I’m always sceptical of trying to decide whether we’re near the bottom of a bear market based on valuations. Market history suggests that turning points are more about psychology than how cheap stocks are in an absolute sense. But there is one valuation indicator that I think is worth a bit of attention: the price/book ratio for the MSCI Asia ex Japan. This has a good record of finding exceptional times to invest in emerging Asia.
The AxJ, as it’s widely known, has changed quite a bit over the years. Go back far enough and it was essentially Hong Kong and Singapore. Then Korea and Taiwan played a growing role. Today it’s about 45% in mainland China, with about 13% each in Taiwan and Korea, and a bit less than 10% each in Hong Kong and India.What’s remained constant is that it’s quite a cyclical index. This is partly because many of the underlying economies are quite export-focused and sensitive to shifts in global growth, and partly because international investors tend to pull money out of Asia whenever there’s a downturn.
Euphoria and despair
That cyclicality is very useful. The AxJ goes through spells of euphoria and despair and the index’s price/book (p/b) ratio is a strong signal for which phase it’s in. Book value measures the value of a company’s assets minus its liabilities (see below). This fluctuates less during a downturn or a bubble than earnings or even dividends, which can make it useful for judging whether the index is cheap or expensive on a long-term view.
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Since MSCI began calculating the AxJ in 1987, the p/b has hit clear lows during the early 1990s recession in the West, the Asian crisis in 1997-1998, the aftermath of the dotcom bust in 2002-2003 and the global financial crisis in 2008-2009. The bottom naturally varies: it dropped below one during the Asian crisis, but only to about 1.2 at other times. However, a strategy of buying when the AxJ is below 1.5 and being ready to sell when it gets close to two has worked well in the past. Last month, the p/b briefly hit a low of around 1.22 before starting to rebound (it’s now up about 18% from that low, on a p/b of 1.44).
We can’t be confident this marks the bottom. Coronavirus is a far greater shock for the world economy than anything we’ve seen in decades – even for Asia, which has so far managed it well. The global rally could fade and hit new lows. Still, a region that was already relatively cheap has hit a level that normally brings strong gains when it rebounds. Caution suggests starting with a small investment – perhaps in a broad ETF such as the Xtrackers MSCI AC Asia ex Japan (LSE: XAXJ) – and seeing how things go before deciding whether to back a recovery more boldly.
I wish I knew what book value was, but I’m too embarrassed to ask
Book value is also known as shareholders’ equity or net asset value (NAV). It is the value of all of a company’s assets, less all of its liabilities (debts) and can be found on the balance sheet in a company’s annual report. Book value is sometimes used as an estimate of what a company would be worth if all of its assets were sold for their balance-sheet values. It’s often used as a way to value firms such as banks, housebuilders, and insurers.
When you know the book value, you can get an idea of how cheap or expensive a share is by dividing the share price by the book value per share (hence the price/book, or p/b, value ratio). A p/b of below one means that – technically speaking – you can buy the company for less than its assets are worth on paper. In other words, if you could buy the whole company, you could sell everything it owned, and still make a profit.
One potential problem with this, of course, is that the book value of a company may not reflect what you would actually get were you to sell its assets. In particular, it may contain lots of intangible assets, such as goodwill, which often relates to the value of a brand. Intangibles – unlike a factory or a piece of land – can be very tricky to measure objectively. They may in fact not be worth very much at all, particularly when they need to be sold urgently. So if a company persistently trades on an unusually low p/b ratio, that could imply investors doubt its assets are worth as much as it claims, rather than meaning it’s a bargain.
If you subtract intangible assets from a company’s book value, you end up with a more conservative number, known as tangible book value, based on hard assets, such as land, buildings, machinery, stocks and cash. You can then divide this figure by the number of shares to get tangible book value per share. If you can buy a stock for a lot less than this figure (a relatively rare event), you may be getting a genuine bargain.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
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