What works in Paris: the Price-Earnings Ratio

In our previous article, we saw that the PER still worked well in Switzerland to predict the future profitability of stocks. The lower it is, the more stocks tend to outperform the market. What about the Paris Stock Exchange?

We will use the same parameters as in my last post, but this time applying them to the French market. If you haven't already, I advise you to take a look at my last analysis, if you want more information on the method used or simply if you don't know what a PER is. I will keep the CHF as the reference currency, so that we can compare the profitability between the two national markets, but it has no impact on the results related to the PER.

Global market

The situation is a little less clean than on the Swiss market. The best-performing stocks are not those with the lowest PER, but those in the previous quintile. This smells like a value trap. This happens when you are dealing with poor quality companies. They trade very cheaply in terms of their earnings, because no one is worth it, for good reasons. After digging a little deeper, I came across a few black sheep like Air France-KLM and Solocal Group:

The stock market downturns caused by these discounted stocks have severely penalized the performance of the 5th quintile. That being said, despite this, the lesson remains broadly valid: the weakest PERs (4th and 5th quintiles) generally perform better than the others.

We also note that the results are less good for all deciles than on the Swiss market. This is logical given that French stocks have only increased by 3,66% per year (in CHF) compared to 8,47% in Switzerland. The 1st quintile was even catastrophic with an average negative annual profitability of -2% for 20 years!

Despite the aforementioned value traps, the last quintile shows an annual profitability of 6,84%. If we compare it to the Swiss market (11,36%), it is quite bad. On the other hand, compared to the French market, it is very good. This is almost double the profitability of the market.

This strategy has worked well over the last twenty years, even if it has been marking time since 2018 (in CHF). It must be said that during the same period, the most expensive stocks have completely collapsed.

Comparison with peers

For the Swiss market, the comparison within industries had given results to be taken with a pinch of salt, due to the size of the samples. Here, it is more coherent, with an image that is quite close to the overall market. The difference comes mainly from the 1st quintile, which moves into positive territory. The following 3 quintiles also perform better, while the last is almost identical. The PER strategy vis-à-vis peers therefore does not bring any added value. On the contrary, it differentiates the extreme quintiles less well.

Big and Mid-Caps

What about if we focus on large and mid-cap companies? Let's just say it right away, it's a joyful mess. There's no trend there. The stocks that have performed the best are at the extremes of valuation. So, among French large and mid-caps, what works is either growth (high PER) or value (low PER). In the middle, it's a no man's land. Worse, over the last decade, the first and last quintile have not even done better than the market, only the second quintile has done well.

We saw on the Swiss market that the sample size explained some outliers. Here, we still have twice as many people in each quantile. This can have an influence, but it does not explain everything. In any case, it is very dIt is difficult to use the PER to make investment decisions about French Big and Mid Caps.

Small, Micro and Nano-Caps

As for Switzerland, we have a much more interesting result with the smallest companies. The gap between the lower and upper quintiles is even more marked than on the global market. Logical, given that we have removed the Big and Mid-Caps that polluted the result. Of course, we still have our value trap in the 5th quintile, but a clear trend is emerging between the most expensive and least expensive stocks in terms of their profits.

Over the past ten years, the 5th quintile has again stood out from the market and especially from the 1st quintile, which has collapsed.

Conclusion

In France, as in Switzerland, a simple strategy consisting each year of buying the securities that are trading the cheapest in relation to their earnings (PER), still works and always will. In Paris, unlike Zurich, we have seen however that the quintile comprising the securities with the lowest PER, was particularly shaken by value traps. We will see, when we talk about qualitative ratios, how to protect ourselves from them.

We have seen that for large and mid-caps, it is difficult to base decisions on the PER. Conversely, for smaller caps, the PER is much more effective. This is a bit paradoxical, because logic would dictate that large companies, which are more closely monitored and controlled, are less subject to accounting shenanigans, unlike small ones.

Perhaps it is simply that large growth companies have been particularly popular in recent decades. Or perhaps the massive presence of institutional investors prevents any form of value-based strategy. It is probably a bit of both.

In the next few posts, I'll continue to backtest among the valuation ratios. I thought I'd focus on something I've probably talked about a few times already... the dividend yield. Unless you have another idea?