The stock market is climbing again and so too are valuations. The 12-month trailing price-to-earnings ratio (P/E) for the S&P 500 is currently around 22, according to FactSet, well above the 10-year average of close to 17.
The P/E ratio measures the price of a stock divided by its earnings per share (in the case of the S&P 500, the “price” is the index level). It’s a measure of how much investors are willing to pay for each dollar of corporate earnings. The higher the ratio, the most “expensive” stocks are (and vice versa).
Today U.S. stocks are relatively expensive, but there are reasons for that. Corporate earnings in the U.S. are growing at the fastest pace since 2010, and the country’s gross domestic product this year is on track to expand by more than 3% for the first time since 2005.
Trade war fears notwithstanding, most economic and market signals are flashing bullish signs, so it’s not surprising to see investors paying up for U.S. stocks.
Slim Pickings In US Stocks For Value Investors
High valuations don’t necessarily mean stocks are poised to fall. If earnings keep rising briskly, stocks may be well-supported regardless of their valuations.
But one thing is certain—it’s a tough time to be a value investor. For those who buy shares of beaten-down companies with low valuations, opportunities are few and far between in the U.S.
In the ETF world, there are only a few U.S.-focused funds with P/E ratios under 10—the iShares Mortgage Real Estate ETF (REM), with a P/E of 7.6; the VanEck Vectors Mortgage REIT Income ETF (MORT), with a P/E of 8; and the US Global Jets ETF (JETS), with a P/E of 9—but they are the exception rather than the rule.
Instead, most of the bargains are found in ETFs that focus on equities outside the U.S. Of the 20 cheapest funds by valuation, the vast majority target international equities, and emerging market stocks in particular.
Of course, an ETF with a low P/E ratio doesn't necessarily mean it's a great investment. It simply means most of the stocks in the fund are trading at low prices compared to their recent earnings.
It's a good starting point for value investors, but it's just the first step in a more comprehensive due diligence process.
Low P/E For Brazil Small-Cap ETF
Taking the mantle as the ETF with the lowest valuation is the VanEck Vectors Brazil Small-Cap ETF (BRF), with a P/E of just 4.7.
Up until recently, BRF had done quite well. It nearly tripled from its low point in 2016 through January of this year. But then it got caught up in the broader downturn in emerging markets—the asset class bruised due to a host of concerns related to the U.S. dollar, trade, politics, debt and deficits.
Big elections scheduled in the country for October adds another layer of uncertainty over Brazil equities.
Investors unfazed by these concerns have the opportunity to buy Brazil small-cap stocks at a discount, which could pay off in the long term.
More Potential Bargains
Similar low P/E’s exist in ETFs tied to other emerging markets such as the Invesco China Real Estate ETF (TAO), along with iShares MSCI Turkey ETF (TUR) and the Franklin FTSE Russia ETF (FLRU), all with price-to-earnings ratios between 6 and 7.
Chinese stocks have been getting battered due to the ongoing trade war with the U.S.; Turkey is in a bona fide currency and debt crisis; and Russia is bracing for potentially more sanctions from the U.S.
As these emerging market cases illustrate, there's no free lunch. ETFs that have low P/Es typically do for a reason. It's up to investors to decide whether those low valuations offer a long-term opportunity.