By Cornelius Zeeman,
Fairtree Portfolio Manager
The S&P 500 has enjoyed a great decade of returns, compounding at 11.5% in US Dollar terms – this means the US Equities now makes out 69.4% of the MSCI World Index. It is, therefore, important to be comfortable with their valuation. For years, it has been a consensus view that the US Market is expensive because they trade at a premium on various conventional metrics like Price/Earnings, Price/Sales, Dividend Yield and Price/Book. We thought the conclusion was too simplistic.
Graph 1: Forward Price/Earnings: USA vs Rest of the World
Source: Fairtree; Bloomberg (as at 18 August 2023)
When judging relative valuations on a multiple basis, you need to consider various factors. These include relative growth prospects, capital intensity, cyclicality and more. The US economy has posted much stronger growth than the EU and other Developed Markets since the Global Financial Crisis – this strong economic growth translated into stronger consumption and, therefore, sales and earnings growth for listed equities. Their regulatory-light and free-market approach has and will continue to attract entrepreneurs and create a fertile environment for innovation. Their Demographic profile is also favourable versus ageing regions like Europe, Japan, and China.
Graph 2: Gross Domestic Product (GDP), Current Prices (USD trillion)
Source: International Monetary Fund; World Economic Outlook (April 2023)
When comparing multiples between Indices, it is important to remember that there are major composition differences. Technology companies dominate the S&P 500. It is already evident when looking at the relative weights of Information Technology in the Graph 3 below.
The difference becomes starker if you consider that heavyweights like Alphabet, Meta, Amazon, and Tesla dominate the US Communication Services and Discretionary sectors. The MSCI World ex-US has much higher weightings in Cyclical and Capital-intensive sectors like Financials, Materials, and Industrials. Ceteris Paribas, these sectors deserve to trade on lower multiples due to their earnings streams’ volatility and their capital intensity. Companies operating in these sectors need to reinvest more cash flows to grow, while the capital-light Internet companies can conduct buybacks or value accretive M&A or maintain higher dividend payout ratios.
Graph 3: Index Composition
Source: MSCI; Index Factsheet (31 July 2023)
Having said that, we do feel that the US Market has become expensive versus the rest of the world over the last two years. Our bottom-up research found many examples of significant valuation mismatches based on listing locations. Below are two examples of where companies have similar operations and geographical exposures, but trading on vastly different multiples:
- Food retailer Koninklijke Ahold Delhaize, listed in the Netherlands but earns more than 70% of profits from the US, trades on a forward P/E of 11.8x, while Walmart trades on 23.2x.
- Food producer JBS, listed in Brazil, trades on 6.1x EV/EBITDA versus Tyson on 10x. JBS is in the process of moving its listing to the US to close this valuation gap.
They aren’t the only company in the process of doing this. AngloGold is willing to spend $560m (>6% of their market cap) to move their listing to the US. Kaspi is also considering moving from London to the USA because they are an e-commerce company growing at >30% per annum but trading on only 9x forward P/E.
Table 1: S&P 500 – Valuation Metrics
Source: Bofa, S&P, Compustat, Bloomberg, FactSet/First Call, BofA US Equity & Quant Strategy
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We are finding fantastic opportunities outside the United States. The Fairtree Global Equity Fund moved from an overweight US position in 2021 to 16% underweight, as the S&P 500’s premium grew from 25 to 45% over the last two years. On an effective see-through revenue exposure, the underweight is smaller.
Graph 4: US Active Weight | Fairtree Global Equity Fund
Source: Fairtree; Bloomberg (as at 15 August 2023)
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