My methodology is simple: I use all major indices pulled from Bloomberg and specifically include other major small cap indices to control for the “size discount”. Then I go and use a range of valuation relative metrics so that we can control for geographic, tax, accounting, gearing and other variables that make indices difficult to compare.
And, except for the Italian Index (FTSE MIB), which is trading cheaply for a very good reason (I wouldn’t want to own it!), South African small and mid caps are the cheapest equity sector in the world. And this is true based on pretty much any measure.
The three major measures:
There’s a chance that South African small caps are always cheaper than these other indices. Could it be that our risks justify our valuations at such discounted levels?
To control for this risk, I have indexed and plotted the JSE Small Cap Index’s Price-to-Book (PB) ratio against that of the MSCI World Index and the FTSE Global Small Cap Index’s PBs. The former is to check against all equity markets while the latter is to check against the “size discount”.
Once again, our South African small cap market appears deeply discounted. While the rest of the world has been getting more expensive over the last two or three years, we have been getting progressively cheaper.
In fact, South African small caps are almost as cheap as they were during the credit crisis. Unlike during the credit crisis, though, everything else is now quite expensive. Hence, South African small caps are pretty much the cheapest equity sector in the world right now.
Keith McLachlan is a small- and mid-cap fund manager.
This article was originally published on smallcaps.co.za here.