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Attractiveness of emerging markets by P/E and implied return on capital

Date: 22 Jan 2012 22:33

The goal of this article is to analyze attractiveness of BRIC and Vietnam stock markets using multiples.

Country attractiveness based on P/E ratio

The multiple which is often used an indicator of investment attractiveness of individual stocks or countries is P/E. Below are its values for a key index in each country plus S&P for comparison.

P/E for key emerging markets indices and S&P

  • China was the most expensive county by P/E since 1996 to 2011 except 2007 when Vietnam took the leadership
  • Vietnam was the most expensive country by P/E in 2007, but lost its leadership to China during 2008 crisis and have never recovered since
  • Russia had always the lowest P/E among BRICs and Vietnam
Questions about the past performance:
  • Can we say based on this data that Russia generated the biggest investment return and China the lowest in the observed timeframe?

P/E for key emerging markets indices and S&P

Questions about the future:
  • Can we say based on this data that Russia and Vietnam are the most attractive for investments for 3-5 years ahead?
  • Can we say that India is the least attractive?

Implied return on equity

Thinking about the questions above, everybody understands that direct comparison of P/E multiples for different stocks or countries is often incorrect as different earnings growth rates are implied. For example, expected growth for Russia in 2012 is about 3.6% while expected growth for China is 8.5%. The multiple which tries to fix this problem is PEG:


where g is taken as g*100 (for example, g=10% is used as 10). PEG multiple is even worse as it doesn't have any financial interpretation.

As P/E is widely calculated and published it's worth using it but with the correct inclusion of g in the formula:


This formula tells that if you want to compare attractiveness of stocks or countries, you should look at the implied return on equity r:

r= 1/(P/E)+g

Then the question which investors should ask is whether the implied return on equity is justified, too high or too low. Below is the implied return on equity for the analyzed indices:

Implied return on equity (re) for key emerging markets indices and S&P

Implied return on equity (re) for key emerging markets indices and S&P

This leads to interesting implications:
  • Before 2008
    • Investors assumed huge cost of equity in Russia
    • China, India and Brazil had similar r since 2001
  • Since 2008 crisis the order of countries changed:
    • Vietnam has the highest implied return on equity since 2009, Russia has the second since 2010
    • Russia stopped being attractive since 2008, and then became attractive for a short period of time at the end of 2008 - beginning of 2009
    • China and Brazil have the lowest implied return on equity
    • India is in the middle and decoupled from China and Brazil
    • Any of the BRICs + Vietnam have at least twice bigger implied return than S&P
Vietnam and Russia are the most attractive countries for investment in public stocks among BRIC + Vietnam.


In calculating implied return on equity the following assumptions were used:
  • g in the formula should be long term expected growth in earnings. It's hard to measure it retrospectively. Instead, g which happened/expected in the next 365 days was used.
  • Also, it's hard to get exactly earnings growth, so GDP growth was used.
  • This approach is theoretically not ideal, but does the job. The main goal of this exercise to broadly incorporate growth expectations in P/E analysis. For example, in 2010 Russia with g=4.0%+11.4%=15.4% is very different from India with g=9.7%+9.6%=19.3% and P/E ratios of these countries cannot be compared directly
  • g = real GDP growth + GDP deflator
  • Period for the above data: g is measured for the 365 days ahead of the time of P/E. For example, for 30 March 2011 real GDP growth =~ ¼ * real GDP growth 2011 + ¾ * real GDP growth 2012
  • When the growth was not available or the period is in the future, short term forecasts were used
  • For GDP deflator forecasts (2011-2013) CPI forecast was used


Below is P/E ratio and implied return on equity for S&P separately as the historical data is available for longer periods than for BRICs and Vietnam: P/E for S&P 1954-2012

Implied return on equity (re) for S&P

Tags: BRIC, Growth Markets, P/E

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