In Search of Quality-Compounder Companies in the Asian Equity Markets
In 2019, the S&P 500 returned an impressive 30%. More than 80% of that return was derived from multiple expansion, resulting in US equity multiples that are now at historically elevated levels. As global investors, the Athena Research team wondered whether there might be somewhere in the world where the potential for shareholder value creation is comparable to that of the US, yet where valuations are more favorable?
Our research led us to the Asian markets. In the years following the Great Financial Crisis, the Asia ex-Japan equity market has meaningfully underperformed the US market, as shown in the table below. Through analyzing this performance, we’ve been inclined to spend more of our time in search of quality-compounder companies in the Asian equity markets.
12/31/2011 to 12/31/2019 (M) Currency: USD
When we try to understand differences in performance between two investments over reasonable time frames, our first step is to look at differences in cumulative value creation. This is because we believe that over time share prices follow per share earnings/book value growth.
Often, we find that the underperformance of an index, a style, or company has been “earned.” That is, the underlying cumulative per share value creation maps to the performance generated (see my posts on investing in international equities and defining growth vs. value).
But other times we find that the comparative value creation has been about the same. This is what we find in the case of the Asia ex-Japan Index and the S&P 500. In the chart below, the gray line represents the difference in cumulative book value per share growth between the Asia ex-Japan Index and the S&P 500. Over the past eight years, the cumulative difference is just about 0%.
Change in Cumulative Book Value/Per Share vs. Change in Price-to-Book of MSCI AC Asia ex-Japan
vs. S&P 500
Source: Bloomberg, FactSet
If it isn’t value creation that explains the difference in performance, our next step is to look at changes in valuation/multiples. In the chart above, the blue shows the significant difference in yearend price-to-book ratios (P/BK) between the MSCI AC Asia ex-Japan and the S&P 500.
When we dive into the price-to-book delta we see that essentially all the delta is due to a rise in the price-to-book of the S&P 500 from around 2.0x at the end of 2011 to more than 3.5x by the end of 2019. Meanwhile, the price-to-book of Asia ex-Japan has hovered around 1.7x.
We are not ones to invest solely on valuation, but we are intrigued and inclined to spend time meeting with managers in search of quality opportunities in a region that, at an index level, has been able to generate comparable book value per share growth, trades at a price-to-book of 1.7x which is comparable to its recent history, and nearly half that of the US. Additionally, Asia ex-Japan, at an index level, trades at 15x earnings (vs 21x for the S&P 500) and provides a nearly 6% free cash flow yield (vs less than 4.5% for the S&P 500).