Tuesday, 13 May 2014

Rule of 20: would it also work in Malaysia?

"A measure of stock valuations called the Rule of 20 states that the stock market is fairly valued when the sum of the average price-earnings ratio and the rate of inflation is equal to 20. Above that level, stocks begin to get expensive; below it, they’re bargains."

The above from Bloomberg BusinessWeek.

The rationale:
  • The higher the PE, the lower the Earnings Yield, the less attractive the valuations are;
  • The higher inflation, the higher the interest rates, the more attractive is the risk free alternative (fixed deposit) for investing.

In Malaysia the PE is around 18 (at least, that is what I read recently).

The inflation is officially about 2%, I guess it is around 5-7%.

In other words, according to the Rule of 20, I think that shares are slightly overvalued.

No comments:

Post a Comment