Are Malaysian shares getting too expensive?
We dive into long-term asset price inflation in our equity markets
Are Malaysian shares / stocks / equities / whatever-you-want-to-call-them getting more expensive over time? If they are, should we be concerned? To find out, we first need a refresher into finance-101. Don’t worry it is not rocket science, and peeling off the layers is important if the public want to make sense of all the technobabble investment professionals keep feeding the media with.
Apples to apples
One of the most popular ways to value shares is by measuring their price-to-earnings ratio (“P/E ratio”). You take the price of a share today and divide by its latest annual earnings. For example: a share trading at RM 10 with annual earnings-per-share (“EPS”) of RM 2 will have a P/E ratio of 5x. Note that if the EPS is below 0 the P/E ratio cannot be calculated, hence why loss-making companies are tricky to value.
What does 5x actually mean? Broadly speaking; it will take you 5 years to get your money’s worth of earnings by owning that share in your portfolio. Whether that is good or bad depends on what better deals you can find elsewhere.
That means this whole P/E ratio exercise is only useful if you do it for a whole bunch of shares… with a whole bunch of peers… covering a whole bunch of years for comparison. Now it gets a bit more complicated.
The most straightforward way of using P/E ratios is to compare companies within a peer group. Company A may be peer to Company B but each have different growth prospects, margins, operating efficiency and leverage. The more market participants favour one company over the other, the more they will bid up the share price of the former compared to the latter. This perceived quality is why some shares are more expensive than others.
In practice, investment professionals would create a comparable table of peer companies and calculate P/E ratios for all shares involved. Repeat this for several years and we will have a nice P/E band to perform our assessment. Bear in mind that both price and earnings are constantly moving goal posts, so we to have incorporate some nuance to paint a fair picture:-
The price nuance is fairly straightforward. The price of a share fluctuates from day to day within a particular year, depending on how actively traded it is on the exchange. For particularly volatile shares, it will not suffice to just take the yearly average, so we have to evaluate the yearly minimums and maximums as well.
EPS on the other hand is a bit more complicated. Some companies have their financial year close conveniently on December 31st, while others close in alternative months such as March. Comparing the EPS directly would not be very fair, since one of them would be outdated compared to the other.
The best approximate is to use Trailing Twelve Months (“TTM”) EPS (available from historical quarterly exchange filings) and Next Twelve Months (“NTM”) EPS (available from analyst coverage) from our assessment date.
What we did
First, we calculated the yearly minimum, yearly maximum and yearly average P/E ratios of each share in the KLSE from 2010 to 2020. We then categorize these shares using the Global Industry Classification Standard taxonomy according to peer group.
To get peer level P/E ratios, we further calculated the median of those yearly minimum, maximum and averages where available (using median as opposed to averages helps smooth out any outliers). We did this for both TTM and NTM to see if market participants judge a particular peer group based on historical performance… or expected future earnings.
Our findings
What we found is mostly what you would expect.
The market is forward-looking. P/E ratios that may seem absurd for historical TTM EPS look a lot more rational when assessed for future NTM EPS. Well duh, you say… but remember TTM is always factual while NTM relies on fairly-tale analyst forecasts.
The market have shifting favourites. Median P/E ratios vary widely between industries and when they pile-up onto one, the median P/E ratios of that industry tend to inflate over time.
Undervalued and Overvalued are relative. Say you pick one random share and calculate its P /E ratio. If that ratio sits between historical yearly min and historical yearly average, then it can be argued that the share is undervalued right now. If that P/E ratio is way off from historical yearly max, it might be overvalued, so stay away unless you are ready to YOLO.
Gloves – a COVID anomaly
What do we make of the craziness that is the gloves industry these last couple of years? P/E ratios have been inching up over time, but the huge spread between min, average and max P/E ratios in 2020 immediately stands out, especially compared to sober 2019.
The extraordinary EPS this industry enjoyed recently due to COVID obviously took the market by surprise, since everyone seemed to be scrambling to assess and reassess how much to pay for these shares. Will the macabre pandemic-fuelled boom for gloves continue, or are we close to seeing the end of the run and now is the time to revert back to normal?
Semiconductors – gradually getting more appreciated.
The marvel of the modern age. The semiconductor industry is the most complex value chain in the world, and we are blessed with many great local companies contributing to this space. However, just because an industry is cool doesn’t mean you can make money owning a part of it. Fundamentally, if you have to wait 80 years to get your money’s worth of earnings by buying a share, you’d be dead by then.
The TTM and NTM P/E ratios for the semiconductor industry are more inflated in 2020 compared to 2019. In fact, they have been on an aggressive uptrend for a while. The market seems to think that future earnings for this industry will be growing faster than they grew in the past.
Palm Oil – boring fundamentals, increasing P/E ratios
The ever so dull palm oil industry with its unchanging structure and fundamentals also has P/E ratios on a general uptrend. We could give the benefit of the doubt to semiconductors with expectations of higher future earnings, but that would be quite a stretch for the palm oil industry due to its relatively limited growth prospects.
Marine Ports and Ships – facing sunset
While many industries have enjoyed greater appreciation by the market, the same cannot be said for marine ports and ships. Trade volume and GDP growth is very much synonymous with this industry, but investors do not seem to appreciate its capital-intensive structure that is unable to produce outsized returns. This is apparent by how the market have been valuing it on both TTM and NTM basis. TTM P/E ratios have stayed the same except for three years in the last decade, while NTM P/E ratios have slowly corroded.
Until that is… 2021 when there is suddenly some excitement again. We intend to write some industry-deep dive articles in the future, so sign up to our newsletter to keep in touch.
Closing thoughts
Notwithstanding anomalies like ports, the data proves that P/E ratios are inflating over time in Malaysian equities. While some may be due to industry-specific excitement (gloves) or improving prospects (semiconductors), the fact that P/E ratio inflation is apparent across the board is rather worrying.
Are we facing systemic asset price inflation? Here… in Malaysia?
This may happen when interest rates are reduced, making loans cheaper (some of which are used to buy equities, drumming up prices). It may also happen through excessive money-printing, which are used to buy short-term government bonds, putting money into the financial system, some of which sloshes around into equities.
The eccentric and bizarre policies in the US the last decade and particularly last year has certainly left many people at awe, but we in Malaysia have not seen quantitative easing or central bank asset purchases like the scale in US or Europe.
So, what gives? While Bank Negara did reduce interest rates from 3% to 1.75% in 2020, we don’t believe that fully explains the general P/E ratio inflation of many industries in Malaysia in the last decade (extraordinary COVID-related monetary and fiscal policies are only 2 years old) . Perhaps the smarter economists can help shed some light into this.
In any case as market participants, we ought to be extra careful of our investing decisions this year.
Disclaimer: Our articles are solely for informational purposes. We do not provide individual financial advice. If you require such advice, contact a certified financial planner so they can review your unique situation and tailor their advice for you. We shall not be responsible for any loss you may bear from your investment decisions.
