As an investor, you generally want to avoid expensive stocks and invest in cheap stocks.
That's not good news if you're an average U.S. investor who has most of your money invested in the U.S. stock market.
According to a recent article in the London-based newspaper, The Telegraph, the United States equity market is the single most expensive market on the planet.
The Telegraph reached its conclusion based on a combination of three different measures: price-to-earnings (P/E) ratio, the cyclically adjusted P/E (commonly known as the CAPE ratio) and the price-to-book (P/B) ratio.
The P/E ratio, of course, is the most commonly used measure of value. You simply take the share price and divide it by the annual earnings per share figure. The lower the P/E ratio is, the better the value.
CAPE ratio is similar to P/E, but it measures average earnings per share over 10 years, and not just the past 12 months, the way a normal P/E ratio does. The longer time frame provides a more accurate measure of value.
Finally, there's the price-to-book ratio, or P/B, which looks at how a company's market value compares with the current value of its assets (e.g. real estate, buildings, machinery and intellectual assets, etc.).
By combining these three valuation measures, The Telegraph generated a much clearer, more balanced measure of the world's most overvalued and undervalued stock markets.
U.S.A. is No. 1 - as in Most Expensive
With a P/E ratio of 21.3, a CAPE ratio of 26.5 and a P/B of 3.01, the United States is overvalued when compared to its historic averages. In fact, the United States stock market was the most overvalued when compared to 34 other major global markets.
The only other stock markets overvalued based on these three key valuation measures were Thailand, Sri Lanka, Indonesia and Belgium.
Valuation doesn't mean much over the short term. Just because stocks in these countries are expensive doesn't mean they aren't performing well. The U.S. stock market is up 6.7% over the past 12 months, while the Sri Lanka market has delivered big time by surging nearly 11.5%.
In contrast, stocks in Indonesia have taken a big hit over the past year, down some 14.3% as measured by the Market Vectors Indonesia Index ETF (NYSEARCA:IDX).
Belgian stocks, as measured by the iShares MSCI Belgium Capped ETF (NYSEARCA:EWK), have basically flatlined for the past 12 months, up a slight 1.2%. Thailand stocks, via the iShares MSCI Thailand Capped ETF (NYSEARCA:THD), are off just 1.6% during the same time.
That's One Cheap Turkey
The flip side of the valuation coin is markets that are considered undervalued or cheap.
Sure, some stock markets are cheap for a reason. And the reason nobody wants to own them is that their fundamentals aren't very good. Yet other markets look to be very attractive based on valuation, and those are the markets you want to consider if you're investing for the long term.
According to The Telegraph, the cheapest market in the world right now is Turkey. Turkey scored an 11.7 P/E ratio, a 16.3 CAPE ratio and a 1.61 P/B ratio.
In terms of performance, Turkey's stock market has really been slammed of late. And that was even before Monday's 6.5% drop after surprise election results that saw the ruling Justice & Development Party (AKP) failing to get the votes it needed to retain full control of the government.
Turkey's stocks (through Monday's close), as measured by the iShares MSCI Turkey ETF (NASDAQ:TUR), are down 26.7% over the past 12 months. Given the political uncertainties, Turkish stocks are cheap for a reason.
Other cheap stock markets include Russia and Japan - two markets that have done very well through the first five-plus months of this year.
The year-to-date moves higher in these cheap markets suggest that the smart money has started to recognize the merit in attractively valued markets.
How to Make Money in Cheap Global Stocks
One exchange-traded fund (ETF) that invests purely based on one of the criteria listed in the Telegraph study - the CAPE ratio - is the Cambria Global Value ETF (BATS:GVAL), a current recommendation in my Alpha Investor Letter newsletter and a core holding in the global investment programs at my firm, Global Guru Capital. NOTE: Global Guru Capital is a Securities and Exchange Commission-registered investment adviser and is not affiliated with Eagle Financial Publications.
Chock full of the world's most hated and obscure stock markets, GVAL is not an easy position to keep. Although it is up 5.7% year to date, it is also 10.53% off its recent highs. The very opposite of a sexy cybersecurity or biotech stock, it is currently seriously oversold and is due for a strong bounce.
But as Sir John Templeton observed:
"People are always asking me where the outlook is good, but that's the wrong question. The right question is: 'Where is the outlook most miserable?'"
Cambria Global Value ETF (GVAL) offers you the opportunity to follow Sir John Templeton's advice.