Equity markets have been led back to record highs by an increasingly narrow and richly-valued cohort of stocks. It’s not the first time such a scenario has occurred, and it seems an appropriate time to dust off the history books to see how past experiences have played out. The MSCI World Index is currently trading at a price-to-book ratio of 2.5 and a price-to-earnings multiple of 21. We would consider these levels high, but while they are well above average, they are not off-the-charts. Given what seems to be an unusually uncertain time in terms of economics and geopolitics, a top-down investor might question the appropriateness of this level of optimism. However, what intrigues us, as bottom-up stock pickers, is the wide range of valuations across the market.
The polarisation of valuations among publicly traded equities is at record extremes, and these particular type of market conditions tend to present a potentially lucrative opportunity for investors who are selective: a subset of the market is trading on extremely stretched valuations, while the rest is valued attractively. It is this spread of valuations that we are interested in examining.