Here's what analysts are saying about the valuations of Saudi stocks

Foreign investment in the Saudi Stock Exchange (Tadawul) has reached an all-time high. 

Foreign investors – including strategic partners – boosted their ownership in the Saudi stocks by 0.44 percent to an all-time high of 7.45 percent in the week ending June 27, 2019.

Although markets across the Gulf and the wider Middle East remain subdued, the rise in foreign investment has pushed the benchmark Tadawul All Share Index (TASI) up 12.7 percent year-to-date (as of June 30 YTD).

The Saudi stock market remains the second best performing in the MENA region YTD after the Kuwait All Share Index, a signal that investor sentiment in the Kingdom’s market is positive.

As the Kingdom’s main market has been showing signs of bullish growth, stock valuations have soared to higher levels.

The valuation story becomes all the more compelling given the trailing 12 months price-to-earnings (P/E) ratio) of Saudi stocks, which is currently hovering around the multiple of 20x.

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PE ratio, in a nutshell, measures the relationship between a company's stock price and the earnings per share (EPS). A stock's P/E ratio simply indicates how much investors are willing to pay for every Riyal of earnings. A high P/E ratio therefore is an indication that investors expect higher earnings.

Generally, a high P/E ratio means that investors are anticipating higher growth in the future. If an investor puts in money in an overvalued stock, there is the risk of losing money if the stock doesn't match high earnings expectations.

Argaam spoke to several market analysts to get a sense of whether or not the current stock valuations would potentially weigh on the market going forward. Here’s what they had to say:

Fahd Iqbal, head of Middle East research, Credit Suisse:

“Saudi valuations are currently rich and reflect the strong inflows related to the emerging market upgrade. In fact, looking at the P/E multiple relative to emerging markets, Saudi Arabia is at the top end of the long term range. The earnings outlook remains quite weak, albeit improving slowly, and is not supportive of the high P/E ratios, in our view.”

Michael Bolliger, Head of Asset Allocation, Emerging Markets, UBS:

“The inclusion of Saudi stocks in the MSCI EM Index has pushed Saudi stocks to higher levels, weighing on various valuation metrics. However, this is nothing new: Saudi stocks have often traded at expensive levels in the past.

We can point toward high dividend yields, ongoing structural reforms which may push potential growth in the medium to long term to higher levels, and the gradual opening of its capital markets as supportive factors.

We think high valuations are to some extent justified by the earnings outlook and technicals, but for this to be sustained, it is crucial that the government keeps up the reform pace and successfully cooperates with the private sector.”   

Mathieu Racheter, Equity Strategy, Emerging Markets, Julius Baer:

“After the strong rally Saudi Arabia valuation is now looking increasingly stretched and could be due to a correction once the technical support coming from flows ease. Earnings growth also does not look supportive with 3 percent 2019E and 7 percent 2020E earnings growth expected, below the expectations of the MSCI EM.

Especially large cap companies look expensive. Nevertheless, we still see some catch-up potential in the midcap space which has been largely ignored by investors so far and offers some catch-up potential.”

Vijay Valecha, Chief Investment Officer, Century Financial:

“Saudi Tadawul index has had a record run this year with YTD gains of approx. 20 percent seen in early May. The current gains near 16 percent correspond to P/E ratio near 19.30 – 19.50 levels.

While this is indicative of expectations of further growth from index constituents, it is also is reflective of the expectations of huge inflows that Saudi markets would get on back of their inclusion in MSCI share index. Q1 2019 earnings from top member constituents further confirm the current rise in valuations.”

Anthony Hobeika, Chief Executive Officer, MENA Research Partners:

“While Saudi stocks historically trade at a premium to regional peers, current ratios reflect the economic potential of Vision 2030 as plans go into execution and start paying off, with financial markets being the first beneficiaries.

This does not rule out that a number of stocks may be trading at expensive levels. Putting it in simple words, the Kingdom is transiting from a period of short term pain to an era of long term gain where forward multiples will start incorporating earning growth.”

Iyad Abu Hweij, Managing Director, Allied Investment Partners:

“The growth factors in KSA should not be immediately overlooked with respect to the KSA stock market. The Kingdom of Saudi Arabia has taken several measures to strengthen the economy, creating the necessary conditions for growth in corporate earnings.

The numerous reform policies and public initiatives could push the potential of the Kingdom’s economy and effectively justify the current valuations.”

Write to Sunil Kumar Singh at sunil.kumar@argaamplus.com