It is observed that there appears to be a diverging trend (in terms of trading price-to-earnings ratio) between FTSE Bursa Malaysia KLCI and FTSE Bursa Malaysia EMAS Index. The FBMKLCI is currently trading at P/E of 16.92x (as of 6 Dec 2016), which is at a discount of 8.4% against the trading P/E of EMAS Index of 18.33x. Is this an ordinary event?
Background – EMAS Index
Malaysia’s FTSE Bursa Malaysia EMAS Index comprises the constituents in the FTSE Bursa Malaysia KLCI,the FTSE Bursa Malaysia Mid 70 Index, and the FTSE Bursa Malaysia Small Cap Index. The index is a free float adjusted market-capitalisation weighted index representing the performance of approximately 98 percent of the Bursa Malaysia Main Market which pass the size, free float, and liquidity screens. As at the end of November there were 263 constituents in the index.
Divergence In Trading P/E Between The Indices
The divergence emerged when the FBMKLCI had recently started to trade at a discount (in terms of relative P/E) against the EMAS Index since 31 May 2016.
Coincidentally, there was a significant spike in trading volume of FBMKLCI on 31 May 2016, as show below:
Before we attempt to answer what are possible reasons for such divergence between FBMKLCI and EMAS Index, let’s perform simple desktop analysis on FBMKLCI and EMAS Index.
Is FBMKLCI statistically overvalued?
The following table / graph tabulates the historical trading P/E of FBMKLCI since Jan 2010 till 6 Dec 2016. This desktop analysis highlights the following:
- Current P/E of FBMKLCI of 16.92x is fairly close to the mean of 16.792x.
- Current P/E is in the bin with the highest frequency of 8.19%
- Statistically, it does not appear that there is significant overvaluation in the FBMKLCI Index
Is EMAS Index statistically overvalued?
The following table / graph tabulates the historical trading P/E of EMAS Index since Jan 2010 till 6 Dec 2016. This desktop analysis highlights the following:
- Current P/E of EMAS Index of 18.33x is relatively further than the mean of 16.08x
- Current P/E is in the bin with relative low frequency of 2.49%
- Statistically (if compared to FBMKLCI), it appears that there is higher probability for relative overvaluation in the EMAS Index
What are possible reasons for divergence in P/E between FBMKLCI and EMAS Index?
The divergence is primarily attributable to different index constituents for both FBMKLCI and EMAS Index. In addition to FBMKLCI (comprised of large cap stocks), the EMAS Index comprises the mid and small-cap stocks. This recent online article (read more) seems to suggest that the small-cap stocks are performing worse than the large-cap stocks. If large and small cap stocks are not doing well, then it must have been the mid-cap stocks that have potentially pushed the trading P/E of the EMAS Index to a point that is relatively higher than EMAS’ historical mean P/E (since Jan 2010).
The higher P/E of mid-cap stocks could have been potentially due to re-balancing in portfolio which involved some movements from the large / small cap stocks to the mid cap stocks (may be in the month of May 2016?). Possible reasons for such movements could have been due to:
- Exit of foreign funds from the large-cap stocks
- Large-cap stocks are tightly held by institutions (i.e relatively lower liquidity, lower trading opportunities?)
- Higher relative risk in small cap stocks (higher beta) in view of prevailing uncertainties
Book Corner: Investing In Knowledge
The price-earnings ratio, or P/E, is the most commonly quoted investment statistic, but have you ever considered what it actually means? For most people it’s a shorthand way of deciding how highly the market regards a company, with investors prepared to overpay for earnings from a high-P/E ‘glamour’ stock as opposed to a low-P/E ‘value’ stock. However, academics have known since 1960 that the opposite is true: value stocks outperform glamour stocks consistently over decades.
A company with a low P/E may have been marked down for no readily apparent reason and thus could represent an attractive value investment for those with the patience to wait while the market re-values it. However, the P/E is a backward-looking measure and just because the company earned £1 per share last year it doesn’t necessarily mean it will earn anything like that in the foreseeable future. Or, a low P/E can mean a company is deservedly cheap because it is in financial difficulty – in this case the company is likely to become cheaper yet or even go into administration.
This book is a practical guide to how you can adjust and improve the price-earnings ratio and use it, alongside other financial ratios, to run against the crowd and boost your stock returns.
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