Some valuation metrics show stocks are rather extended
Some measures of equity valuations are flashing more worrying signals than others, with the shares of US companies being particularly vulnerable should the malaise in the equity space begin to feed "more meaningfully" into credit markets, analysts at Societe Generale think.
For that reason, when the broker analyses valuations it prefers to look at both price-to-earnings multiples and EV/EBITDA ratios. The latter help to reflect the large amounts of debt which have been added to balance sheets in recent years and which can "become problematic in downswings".
Median price-to-earnings multiples are at the top of their 10-year range. However, EV/EBITDA ratios "have rarely been this high over the full 20 year period, even after the recent sell-off," the analysts explained in a research note e-mailed to clients.
The French broker also recommended looking at median valuations instead of aggregate ones. That helps to avoid a few "mega cap" stocks from "heavily distorting" the data.
"Given this and that US companies require approximately US$400bn per annum to fund existing investment and share buyback commitments, we think the US equity market is particularly at risk of the current equity market malaise feeding more meaningfully into credit markets," Societe General concluded.