Comparing “Cheapness” Across Countries
If you read financial news, it’s easy to compare markets to one another. All you need to do is compare price to earnings, price to cash flow, and price to book. Using these ratios, articles can be written determining the relative attractiveness of investing in different markets.
In fact the “Heard on the Street” column on Friday compares these ratios between Japan, the U.S, the U.K., and the world and comes to the conclusion that Japan is relatively cheap. While their conclusions may be correct, their analysis is overly simplistic.
I am not an expert by any means in international accounting or Japanese securities but what I do know was not even addressed in the article. First, international accounting differences affect the income statement, cash flow statement, and balance sheet. This will change the “normal” P/E, P/CF, and P/B ratios across countries.
Second, Japanese companies have significant cross ownership. This means that earnings and cash flow will likely be higher than reported, raising expected P/E and P/CF ratios. Any analyses should at least acknowledge the shortcomings inherent in ratio comparisons across industries, let alone countries.
