Yesterday it was the FTSE’s turn. The Dow Jones
has been hitting new highs with such regularity, that it’s no longer news. The FTSE 100, on the other hand,
is still 715 points short of the all time high of 6930.2, set on the last day of the last
millennium, but it’s getting closer. Ten days ago it passed the five year market high, that
had previously been set in May, which meant it had recovered from the spring crash in
just a few months. Since then, it has risen a further 51 points. It’s not the heady stuff seen
in the US, where the Dow is now more than 400 points above the former all time high of
11722 set on January 14 2000 (and which had remained as an elusive record for over six
years until early October). Even so, it’s still a good run, and who knows, the FTSE could hit a record by the year’s end. But the question is this: when
the US economy is expected to slow, and when the UK economy is doing okay, but by no
means booming above trend, why are the markets so strong?
In part, of course it’s down to corporate results, which are doing very nicely. But
maybe there’s more.
In the long term, shouldn’t there be a relationship between a
company’s profitability and earnings and the rate of interest? Remember, the rate of
interest just offers a yield, say 5 percent. If a company is generating a profit in excess of
five percent of its market valuation (so that’s a pe ratio of 20), that company should
represent an attractive alternative to a cash investment. But take into account that you
would expect the profitability to grow each year - then the equity investment should win
hands down.
And yet, in recent years, while the rate of interest has been low (it’s still relatively
low in historical terms), pe ratios have been relatively low too. You would perhaps have
expected the opposite.
BDO Stoy Hayward produce some definitive data on historical pe ratios. And they
show that, in the second quarter of this year, the average pe ratio for a non financial
company, at 14.4, was the lowest level for at least nine years. (The data available doesn’t
go back any further).
The charting web site Trade 10 indicates that typical pe ratios for the Standard and
Poor 500 are at their lowest this decade.
Combine this with data showing that the money supply is growing, and perhaps you
can begin to understand why private equity acquisitions are all the rage.
And, as often as not, company acquisitions, whether they are private equity, or
corporate, such as the impending takeover of Corus by Indian company Tata, often
involve borrowing to fund the deal against the assets of the company they are buying. How can they
do this? Because the rate of interest, relative to the pe ratio, is low.
Maybe this, in part, builds upon the carry trade, which is based on the idea that the
excess liquidity sloshing around the economy at the moment has its routes in Japan,
where the rate of interest is much lower. So people borrow in Japan and lend elsewhere.
So, while company valuations are soaring, the pe ratios are not.
But take a different perspective and, instead of examining quoted companies, have a
look at unquoted businesses.
If you are looking to sell your company, you may be interested to know that typical
pe ratios for unquoted companies sold, is now approaching a record. According to BDO
Stoy Hayward, this ratio is now 14.4 - it has been higher, hitting 14.7 in 2000 - but, that
aside, it’s the highest level seen since 1997.
For further information
Private Equity Price IndexBDO Stiy Hayward
Price Earnings Ratio
Trade10.com
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