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Morgan Stanley IM: Valuations have gone down, but risks haven't

The good thing about stocks is that there are only two ways you can lose money - falling profits or falling valuations. A year ago, it was reviews that were of greatest concern to us. After the markets rallied in 2017, the MSCI World Index was trading at 17 times its earnings for the next twelve months.1 This indicated that markets were pricing in the unlikely positive scenario of global synchronous growth - while risking significant losses if they did not everything should go according to plan. At the beginning of 2019, on the other hand, the MSCI World Index was quoted at 13.4 times the expected earnings and is thus 14% below the average price / earnings ratio (P / E) over 20 years of 15.5 and 20% below the previous year's value. 2 Our biggest concerns are no longer valuations, but profits.

"Our biggest worries are no longer the ratings, but the profits"

Earnings forecasting continues to create a general discomfort in us because it involves guessing about falsehood. These are assumptions because the sell-side is always over-optimistic and its one-year forecasts deviate from actual profits by an average of 8%. This figure is slightly above the 7% that the MSCI World Index earnings growth is estimated at for 2019.3 The falsehoods stem from the gap that exists between the “adjusted” earnings that the consensus figures (and the salaries of managers ) and the actual reported profits (GAAP / IFRS) that appear on the income statement. In the United States alone, the difference between adjusted and actual earnings over the past three years was $ 600 billion - an exaggeration of earnings averaging 21% .5 Our more specific fear stems from the fact that markets appear cheap only on the basis of leveraged earnings. If you look at the company value (EV / EBITDA) 6 instead of the P / E ratio, the discount compared to the historical average disappears and the market valuation of 9.2 is slightly above the value of 2003 (9.0) when the P / E ratio of 17, 6 peaked. 7 Lower corporate taxes play a role, but so does the drastic rise in debt, which we will discuss in more detail later in this post. A look at the relationship between company value and sales shows that the MSCI World Index continues to exceed its 20-year average with a value of 1.8 by 16 %.8 The combination of an expensive market for sales and a “cheap” market for the profits reflect the current high level of profitability. In the USA in particular, all the driving factors for profits seem to be exhausted - be it big margins, low taxes, high debt or low interest rates.

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