In a recent paper, Paul Boyne, global equities fund manager at Manulife AM, said global equity markets are currently highly valued, but this does not concern him as a stock picker.
This is despite the key bubble metric of the Cyclically Adjusted Price-Earnings (CAPE) ratio reaching its third highest level since records began.
Boyne noted that as of late April, the CAPE ratio, calculated by taking the S&P 500 and dividing it by the 10-year earnings average, stood at 29.44 and has only been higher twice: just prior to the 1929 Wall Street Crash and before the 2000 dotcom bubble.
He said that on this measure alone, equity valuations are stretched, having been lifted by the “wave of optimism” that has taken hold since last November.
“We think one would need to head back to the early 2000s to see comparable price/earnings multiples,” he said.
But Boyne urged investors to use more metrics than just the CAPE ratio to make stock-picking decisions, highlighting his current focus on quality and value.
Among these metrics is the Enterprise multiple – a ratio frequently used by advisers involved in mergers and acquisitions – and the Du Pont Analysis, a metric used to identify regions where corporate earnings and margins have room to grow.
Investors should also keep an eye on company leverage levels and the interest rate coverage ratio, which determines how easily a company can pay interest expenses on outstanding debt, Boyne argued.
Boyne said: “It is easy to forget that when an investor buys a company’s shares, he or she is investing in a business as opposed to a specific index or price level; that stock represents fractional ownership of a real business, operating in one of many industries that are as complex as they are competitive.
“As bottom-up, long-term investors, we believe it is important to focus on the optimal mix between quality and valuation as this intersection of the market is rewarded over the long-term.”
In terms of sectors, Boyne sees opportunities in the financial sector, although has a very cautious view of European banking, as well as sustainable quality franchises within consumer staples.
However, his portfolio is underweight the most expensive markets and he maintains a negative view of the utilities sector.
