Unlocking Value: A Deep Dive into Brazilian Equity Valuation
As the equity valuation section was lost in the middle of our long analysis of the institutional evolution of Brazil, we realize that many probably did not reach the part where we discussed about the valuation of the Brazilian market and what it means for future return so here it is… We will do the same for the currency valuation and another piece on our stock selection methodology.
Current equity valuation models suggest that Brazilian stocks are attractively priced, offering significant upside potential:
We use the Price to Sales ratio instead of the Shiller CAPE ratio as we only have 14 years of data for the latter.
Both tends to behave similarly and have the advantage of normalizing profit margins (even if profit margin remaining above competitive levels for > 10 years still can distort the message see:
https://quantasticworld.substack.com/p/us-market-valuation-one-for-the-history
https://quantasticworld.substack.com/p/unlocking-the-secrets-of-american
We have also added our median ratios graphs even though the data is only limited.
Here you can see the relationship between initial PS and forward 7 years total return.
Here is the same with the Shiller CAPE (data courtesy of Barclays) but with a much lower sample.
Sales, as in most emerging markets, have grown less than the economy but our dilution proxy (market cap/price index) is less dramatic than in many other places.
We can also see that, relative to profit margins, today’s PS is not demanding.
Total debt to enterprise value is much higher than in the early 2000’s but has declined substantially since its 2016 peak.
For data nerds here are a few more graphs looking at the median value of various ratios (a concept we introduced in 2013). It has the advantage of not having a few mega cap distorting the message.
When evaluating Brazilian companies and managers, it's crucial to consider the unique economic environment they operate in. Brazil's high-interest rate landscape has created a natural selection process where only the most resilient and efficient businesses can thrive. This stands in stark contrast to countries where central banks have maintained near-zero interest rates and engaged in extensive government debt purchases.
In Brazil's challenging financial ecosystem:
Companies must be highly efficient and well-managed to generate returns above the high cost of capital.
Managers are forced to make strategic decisions under tighter financial constraints, fostering innovation and prudent resource allocation.
The market naturally weeds out weaker businesses, leaving a landscape of more robust and competitive firms.
This environment has prevented the "zombification" of markets seen in some developed economies, where ultra-low interest rates have allowed less productive firms to survive artificially. As a result, Brazilian companies that succeed in this high-stakes environment often demonstrate superior financial discipline and adaptability, potentially offering more sustainable long-term value for investors.
Conclusion
The analysis of Brazilian equity market valuation reveals a compelling investment opportunity.
Current valuation metrics, including the Price to Sales ratio and various median value ratios, indicate that Brazilian stocks are trading at a discount relative to their historical averages. This suggests significant upside potential for investors willing to enter the market.
Brazil's unique high-interest rate environment has fostered a landscape of resilient, efficient, and well-managed companies. This natural selection process has created a market of survivors – businesses that have proven their ability to generate returns above the high cost of capital and adapt to challenging economic conditions.
While risks remain, including political uncertainty and global economic headwinds, the current valuation levels appear to offer a favorable risk-reward profile. The combination of attractive valuations and battle-tested companies positions Brazilian equities as an intriguing option for investors seeking exposure to emerging markets with potential for substantial returns.
As with any investment decision, thorough due diligence and careful consideration of individual risk tolerance are essential. However, for those willing to navigate the complexities of the Brazilian market, the current equity valuations suggest that now may be an opportune time to consider increasing exposure to this dynamic South American economy.
P.S:Reassuring to see that Research Affiliates arrive at the same conclusion
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