There’s a nice upside to the dismal underperformance of Canada’s benchmark index: What was once a pricey group of stocks has fallen back in line with the global average.
Canada’s S&P/TSX composite index has certainly fallen from grace over the past couple of years. There was last year’s 11 per cent tumble, even as the S&P 500 ended the year unchanged. And this year, the TSX is down more than 5 per cent, lagging the S&P 500 by about 10 percentage points.
But as UBS strategists George Vasic and Garry Cooper argue, this brutal underperformance has brought the index’s valuation down to far more reasonable levels after being overvalued for some time.
“The result has been that the premium that had ranged to nearly 20 per cent has been eliminated, and the TSX’s valuations are back into line with that of the other major regions for the first time since early 2010.”
Rather than focus on price-to-earnings ratios, the strategists instead compare the price-to-book ratio to return on equity. For the S&P/TSX composite index, the price-to-book ratio is now 1.9 and return on equity is projected as 17 per cent, putting the index’s relative valuation just 0.4 per cent higher than global indexes.
In terms of sector valuations, materials, industrials and financials have valuations that are only slightly higher than their global peers. Telecommunications and consumer staples have valuations that are slightly lower than their peers.
While energy stocks look overvalued using this approach and information technology stocks look tremendously undervalued, the strategists said that their approach isn’t applicable for these two sectors.