Crunching the Russian equities valuation puzzle


“Russia is always cheap” is common notion among investors. At first glance it appears to be true. Over the last decade the average price/earnings (P/E) ratio discount for the MSCI Russia index to the MSCI Emerging Markets index was 50%. Russian equities were never close to broader emerging market (EM) equities on a P/E ratio basis.

However, upon closer inspection this structural cheapness is actually a myth due to:

  • The difference between the structures of the Russian and EM equity indices. The MSCI Russia index has large weights in mature, highly cyclical energy (59%) and materials (14%) stocks, which tend to be cheap relative to the broader market. The MSCI EM index has larger weights in new high-growth, high return sectors such as IT (27%) and consumer discretionary (9%), which tend to command a premium valuation relative to the overall market. If one adjusts for these differing weightings, the average P/E discount for Russia comes down from 50% to 40%.
  • Energy sector earnings are of poor quality, as depreciation does not fully reflect the amount of maintenance capital expenditure that energy companies have to undertake. If one adjusts energy companies’ earnings accordingly in addition to the previous adjustment, the average P/E discount for Russia falls to 7%.