What is good value? The summer sales may have hit the high street, but thanks to a multi-year rallies, stocks in the UK, US and Europe are no longer as cheap as they once were. But according to advisory firm Tilney’s chief investment officer Christopher Godding if you are investing for the long term, stock valuations do not matter.
Looking at the sources of stock market returns decade by decade in the UK, price to earnings ratios are one of the largest contributors to gains. In the 2010s, P/E made up nearly two thirds of positive returns. But if you take a longer term view – from 1969 to 2016, P/E becomes inconsequential, with inflation and dividend yield making up 95% of total returns.
“Valuation does not matter as a long-term source of returns,” said Godding this week. “Therefore for long-term investors, the price of a stock does not matter. The entry point does not matter. Inflation and dividends matter.”
The total annual return of the MSCI UK index from 1969 was 10.37%, with dividend yield contributing 3.51% and inflation contributing 5.87%. Change in valuation only contributes 0.92% annually.
However, Godding recognises that it is not always possible to have such a long-term view as an investor.
“It is not always possible to have a 100-year view like the Welcome Foundation. People review their investments every three years now,” he said.
What Next for Stock Market Returns?
Tilney’s outlook stock markets is muted compared to the past three years. Although they expect positive real returns for investors, they warn that markets will plateau in the second half of this year.
“On the surface, the underlying outlook for the global economy remains supportive for equities but there are a number of factors which lead us to expect a ‘pause’ in markets over the coming months,” said Godding.
Emerging markets have performed particularly well over the past 12 months, up more than 20% over the year, while developed markets are up around 10%. Godding stressed that equities are dependent on earnings growth and fiscal policy rather than valuation re-rating.
“Global growth needs to pick up,” says Godding. “We expect less from global equities for the rest of this year. We need an economy to pick up the baton for fiscal stimulus as the US winds down. Where will fiscal input come from and will it be enough that investor sentiment improves? It is confidence that will keep us steady.”
Godding tipped developed Asia-Pacific stocks and emerging markets as the best places for growth opportunities, and is negative on the outlook for the US stock market. Tilney has recently taken profits from European stocks.
