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

Reprinted by permission. Copyright © 2023 Bank of America Corporation (“BAC”). The use of the above in no way implies that BAC or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of the use of such information. The information is provided “as is” and none of BAC or any of its affiliates warrants the accuracy or completeness of the information.

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)

Disclaimer: 

Fairtree Asset Management (Pty) Ltd is an authorised financial services provider (FSP 25917). Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CISs are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. Performance has been calculated using net NAV to NAV numbers with income reinvested. There is no guarantee in respect of capital or returns in a portfolio. Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45 of 2002). For any additional information such as fund prices, fees, brochures, minimum disclosure documents and application forms please go to www.fairtree.com.