The P/E ratio of public listed companies around the world (ex-U.S.) has fallen to levels below long-term average. It would seem equities are attractively priced. But before one draws such conclusion, one must re-examine if the basis of comparing the current ratios with the historical ones is still valid.
In recent years, the accounting standards outside of U.S. have undergone major revamp to the extent that the 'E' (i.e. Earning) in the ratio differs materially from the historical ones. And if the denominator of an ratio can not be measured consistently, the temporal ratios cannot be comparable to arrive at relative value.
I would like to highlight two of the significant changes: treatment of goodwill and Mark-to-market accounting:
1. Following introduction IFRS 3 in 2004 goodwill arising from business combination needs no longer be amortised to profit and loss accounts as expenses unless material impairments can be established. As a result, from 2005 onwards, earnings at companies generally received a boost when compared with pre-2004 results;
2. The principle of mark-to-market accounting is simply that of stating asset values at market prices at time of reporting. Previously, the concept was generally observed for current assets but not for non-current assets which were stated at historical costs. The historically cost accounting of non-current assets are gradually replaced by that of mark-to-market. The constant changes in market condition therefore necessitate companies to periodically revaluing more and more of their balance sheet items and reporting the differences as profits or losses. These non-operating-in-nature adjustments render the profit and loss account a less effective gauge of operation results. Case in point: the recent property and equity bubbles has given rise to revaluation in so many companies, especially the property counters, that their 2007 results are breaking all previous records.
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