If a cashed-up billionaire like Warren Buffett goes on a shopping spree, he might evaluate a takeover target by comparing its share price to its core earnings.
And after the recent sell-off, this measure of value and others suggest it is a very good time to buy, both in the US and in Hong Kong.
Locally, the 46 member-companies of the Hang Seng Index are trading at 6.13 times this year's forecasted earnings before interest, tax, depreciation and amortisation (ebitda). That is the cheapest local stocks have been in the 19 years Bloomberg has tracked this data - slightly below the benchmark index's 6.66 price-to-ebitda ratio for all of 2008.
Indeed, value is emerging globally. New York's S&P 500 index is priced at 5.5 times 2011 ebitda, slightly above its 2008 low of 4.94 times. So buying is exactly what Buffett is doing. Over the weekend, Berkshire Hathaway made an unsolicited US$3.25 billion all-cash bid for New York-listed insurer Transatlantic Holdings. Even before the recent sell-down, valuations were looking attractive. Berkshire spent US$3.62 billion in the second quarter investing in stocks, the most in almost three years.
It is not only that stocks look cheap. If the bears are right - and the developed world is indeed heading for a double-dip recession - companies look much better positioned this time around. This is especially true in Hong Kong, where Hang Seng Index firms boast increasingly robust balance sheets.
From a low point of almost HK$8,000 in net debt per share on average in 2006, the index companies have slashed loans and other liabilities progressively since the financial crisis, and currently sit on nearly HK$3,000 per share in net cash on average, according to Bloomberg data. So companies are better capitalised to ride out a storm. But what if there isn't one?
On average, analysts are forecasting benchmark index companies to see sales growth per share of 4.3 per cent this year and 10.1 per cent next year. Profit is expected to outpace sales, given most firms have improved their operating leverage in the three years since the outbreak of the financial crisis.
Analysts expect the Hang Seng Index to achieve an 11.2 per cent rise in average earnings per share this year, and growth of 13.5 per cent next year. Those projections may have to be slashed if the global economy slumps in the coming months. And markets may well slump further.
Regardless, investors are in for a rough ride in the near term. The Hang Seng Volatility Index yesterday jumped to 51.97 points - its highest level since the market hit a post-crisis bottom in March 2009.
But if a double-dip downturn is imminent, local firms are likely to prove much better swimmers the second time around.