Disruption creates more value traps
Challenged companies are likely to experience slower revenue and earnings growth over the next 10 years than they did in the previous decade, Giroux warns. The hit to valuations could be dramatic. “When companies fall into the secularly challenged bucket, what we normally see is that multiples compress even more than earnings growth,” he says. “Those can be horrible stocks to own.”
This same bifurcation is playing out in other global equity markets, Thomson says. Japan is a case in point: Although the MSCI Japan Index sported a relatively low 12.03 P/E ratio as of October 31, 2018, the Japanese market is sharply divided between firms that are increasing shareholder returns and those that are essentially stagnating.
“In situations like that,” Thomson says, “the aggregate multiple doesn’t give you much useful information.” On the other hand, structural change may have made aggregate EM equity valuations more attractive. As of the end of third quarter 2018, technology accounted for 27% of the MSCI Emerging Markets Index, up from virtually nothing 10 years ago, Thomson notes.
This reflects not only the growth of China’s own technology giants, but also the rise of other high‑value EM industries based on intellectual property. “You not only have strong growth potential, but the opportunity set is widening and deepening as well.”