Monday, November 29, 2010

ETF Overview: Risk Premiums for Some Countries.

"RUSSIAN RTS INDEX $ (priced in USD)" trades at eight times earning, meanwhile S&P500 has 14.891 (approximately 13-14 P/E for next year). Assume that US Equity market is correctly priced. So, based on the comparative P/E ratio we conclude that investors agree to pay only 54 cents for one dollar of profit. Is it normal? Actually I don't know. Let's estimate risk premium for some countries.

Equity Risk Premium (US).

First metric is difference between the geometric average of historical rates of returnable on equity market and 10-years Treasury Bonds - 9.26% and 4.97% respectively (for the period 1928-2009). Premium is equal 4.29% (see Historical Returns on Stocks, Bonds and Bills - United States, for instance).

Second one - difference between current or expected Earn-Price ratio and current 10-years Treasury Bonds Yield (we used current Earn-Price ratio). It's aproximately 4.09%. If we assume that expected P/E is equal 14, given this, we get 4.52%.

At the third, Implied Equity Risk Premium. Parameters used in model and results see in following table.


Table 1: Implied Equity Risk Premium (US)
At Nov 25th 2010.

S&P 500 INDEX (20-Day Average), pts
1199.58
Dividends and Buybacks Trailing 12-m, pts
48.2
Expected growth rate in earnings for next 5-y, %
7.2
Expected growth rate in the long term, %
2.84
CBOE Interest Rate 10-Year (5-Day Average), %
2.84
Expected income rate, %
7.51
Implied Equity Risk Premium, %
4.67

Sources: finance.yahoo.com, standardandpoors.com, damodaran.com
Calculations: invest2russia.blogspot.com
So we have three estimates of equity risk premium, which are enough closely each to other. Let us assume that risk premium is 4.67% and expected rate of return on equity is equal 7.75% (free risk "plus" risk premium) for US market.


Country Risk Rates.

There are many approaches to estimate Country Risk Premia. We use following ones: approach based on Moody's Long-Term Credit Rating, based upon AAA-JPM CEMBI yield spread market volatility adjusted and upon the CDS-rates volatility adjusted.
Table 2: Bonds and rates

Country
Moody's LT Rating
10Y-Gov bond local currency, %
JPM CEMBI, pts
CDSs, %
Brazil
Baa3
12.50
5.94
1.15
China
A1
3.99
7.99
0.74
Hong Kong
Aa2
2.66
4.78
0.43
India
Ba2
8.38
5.34
1.26
Indonesian
Ba2
7.50
7.15
1.02
Mexico
Baa1
6.27
5.75
1.18
Russia
Baa1
7.73
5.79
1.63
Australia
Aaa
5.500

0.83
Japan
Aa2
1.160

0.61
U.K.
Aaa
3.361

0.70
USA
Aaa
2.91




Sources: wsj.com, markit.com, bloomberg.com


Table 3: Equity Markets (local currency)
Country
Index
Risk, %
P/E
E/P, %
Brazil
IBOV
17.85
13.75
7.28
China
SHSZ300
26.41
18.95
5.28
Hong Kong
HSI
15.84
11.75
8.51
India
SENSEX
15.59
14.12
7.08
Indonesian
INDEXCF
15.77
17.55
5.70
Mexico
MEXBOL
12.71
17.48
5.72
Russia
INDEXCF
15.30
8.76
11.41
Australia
AS52
13.64
39.41
2.54
Japan
TPX
17.31
15.62
6.40
U.K.
UKX
15.15
16.87
5.93
USA
SPX
15.34
14.89
6.72


Sources:bloomberg.com


Table 4: Equity Markets (US dollars)
Country
Index
Risk, %
P/E
E/P, %
Brazil
MXBR
22.47
12.47
8.02
China
MXCN
17.02
14.59
6.85
Hong Kong
MXHK
14.48
12.81
7.80
India
MXIN
16.07
17.41
5.74
Mexico
MXMX
17.35
19.70
5.08
Russia
MXRU
19.72
8.13
12.31
Australia
MXAU
13.85
16.34
6.12
Japan
MXJP
17.53
15.50
6.45
U.K.
MXGB
15.06
16.88
5.92
USA
SPX
15.34
14.89
6.72


Sources:bloomberg.com

Table 5: Country Risk Premium

Country
Based upon   Moody's rating
Based upon JPM CEMBI-AAA Spread
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Brazil
3.00
1.44
5.45
6.47
China
1.35
3.49
7.43
3.51
Hong Kong
0.90
0.28
0.85
1.90
India
4.50
0.84
2.53
4.93
Indonesian
4.50
2.65


Mexico
2.40
1.25
3.77
5.08
Russia
2.40
1.29
4.39
7.18
Australia



3.13
Japan
0.90


3.11
U.K.



2.99
USA



0.00

Sources: damodaran.com
Calculations: invest2russia.blogspot.com

Table 6: Total Risk Premium

Country
Based upon   Moody's rating
Based upon JPM CEMBI-AAA Spread
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Brazil
7.67
6.11
10.12
11.14
China
6.02
8.16
12.10
8.18
Hong Kong
5.57
4.95
5.52
6.57
India
9.17
5.51
7.20
9.60
Indonesian
9.17
5.92


Mexico
7.07
5.92
8.44
9.75
Russia
7.07
5.96
9.06
11.85
Australia
4.67


7.80
Japan
5.57


7.78
U.K.
4.67


7.66
USA
4.67


4.67

Calculations: invest2russia.blogspot.com

Table 7: Expected Rate of Return (free risk rate "plus" total premium)

Country
Based upon Moody's rating
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Average
Brazil
10.51
12.96
13.98
12.48
China
8.86
14.94
11.02
11.61
Hong Kong
8.41
8.36
9.41
8.73
India
12.01
10.04
12.44
11.50
Indonesian
12.01


12.01
Mexico
9.91
11.28
12.59
11.26
Russia
9.91
11.90
14.69
12.17
Australia
7.51

10.64
9.08
Japan
8.41

10.62
9.52
U.K.
7.51

10.50
9.01
USA
7.51

7.51
7.51

Calculations: invest2russia.blogspot.com

What does it means? (Conclusion)

We can use these results as estimation of required rates of return for equity markets, for the risk weighting purposes and P/E forecasting.

Actual current P/E for S&P500 is equal 14.891 times earning. Expecting P/E is 13.32. Its very close to some forecasts. Russia has 8.22 current and 8.13 estimated P/E. It's close to actual ratio too. In other words 55 cents for one dollar of current profit in Russia is normal. Also Hong Kong trades near its P/E estimation.

Following our results, required rates of return on equity are 12.48, 11.61 and 11.5 for Brazil, China and India respectively. Current earn-prices marks are equal 8.02, 6.85 and 5.74. So Brazilian, Chinese and Indian companies should increase their profit. The expecting GDP's growth looks like the great opportunity for companies from these countries to demonstrate the rising of their earning. Otherwise if they will not use it Investors will be very disappointed (it looks very risky). In a nutshell there are no significant upside potential and very weak downside protection at this moment.

No comments:

Post a Comment

Post a Comment