Leading European equity indices are 7–12% more expensive now than at the start of 2015. For example, the FTSE-100 index currently trades at a calendar year 2015 estimated P/E multiple of 18.9x (source: FactSet consensus data), an expansion of 148 basis points compared with 17.5x at the start of the year, an 8.4% re-rating.
We note that increasingly stronger equity valuations are not a purely European issue, as the STOXX Global 1800 index has re-rated by 10.2% over the same period.
Furthermore, current P/E multiples are not only expanding, they are also getting close to historical highs. For example, the entire UK equity market (FactSet aggregate data) currently trades at a CY’15E P/E of 16.7x, representing a 14% premium to the 2000–2014 historical average of 14.6x.
Consequently, both sell-side analysts and investors are getting nervous and market sentiment has deteriorated in recent months.
The share of sell-side buy/overweight recommendations has been falling across the board on the back of very strong price performance year-to-date, particularly in Continental Europe, boosted by the ECB’s quantitative easing measures. For example, the share of positive (buy/overweight) ratings among all DAX companies is 38.1% today, a drop of almost ten percentage points from 47.6% of positive at the start of the year.
To rate a stock positively, analysts have to offer some upside to their price target (usually at least 10%). With raising share prices, analysts have basically two ways to continue offering upside potential: 1) raise earnings estimates, which has to be supported by strong trading updates, or 2) apply higher target multiples to earnings forecasts. In other words, stock ratings are being downgraded because analysts can’t justify increasing their earnings projections in a fairly muted macro environment. Again, this is even more evident in Continental Europe, where quantitative easing is first and foremost aimed at reviving sluggish Eurozone economies.
Investors are also getting more nervous about equities. The April 2015 Bank of America Merrill Lynch fund manager survey highlights the deterioration in investor perception of European stocks since the start of the year.
A net 8% of worldwide respondents said that European equities were overvalued in February, rising to 23% in March and then 25% in April survey. Manish Kabra, European Equity and Quantitative Strategist at Merrill Lynch noted: “We are seeing a form of rational exuberance in Europe where a positive view on stocks is supported by fundamentals – but investors no longer believe valuations are cheap.”
The belief that European equities are now overvalued is not limited to international investors. In March a net 3% of European managers believed European equities were undervalued, yet in the April survey, sentiment shifted significantly, with a net 10% now saying Europe is overvalued.
While this sentiment prevails, it is worth noting that global investors see the US as the most overvalued market, with 68% of respondents holding this view. However, we would add that, in comparison, the US is in a much better position in terms of earnings recovery potential.
What does it all mean for quoted companies?
When equity valuations are getting stronger and trending above the historical average, it becomes increasingly challenging for active fund managers to generate alpha (and justify charging more than tracker funds). This may well mean an increased focus on portfolio rationalisation and a more thorough review of what constitutes top picks and best investment ideas.
In this context, and also given the changing dynamics of the corporate access market in the UK, quoted companies, particularly the smaller ones, need to be even more proactive with their engagement with shareholders and potential investors.
Investor targeting is not simply about identifying and prioritising investors, whether current shareholders that could invest more, or absentee investors that could re-invest or invest for the first time. Good targeting is also about developing high quality relationships with target investors in order to gauge their sentiment towards your stock and to provide them with adequate information about your stock in order that they can make an informed choice about monitoring your stock and/or meeting with you.
A list of targets is only useful if acted upon methodically and quickly, via direct outreach, to investors on a global basis. Such an exercise can be very time-consuming for in-house IR teams, as a targeting campaign may involve hundreds of target investors. The companies that most need this type of campaign are very often also those with more limited internal resources.
RD:IR is well-versed in helping corporates reach out to investors, gathering useful feedback from the buy-side within a short period of time, as well as providing quarterly updates on target sentiment, keeping the target lists fresh and current.
Please do not hesitate to contact us to discuss our Targeting / Investor Access services or any of our other IR services in more detail.
Authors: Mark Robinson (Senior Client Manager – European Issuer Services) & Philippe Ronceau (Senior IR Consultant)