BEER Ratio Indicates High Valuation as Pressure Point for Equities

A financial metric, the Bond Equity Earnings Yields (BEER) ratio, indicates that Nigerian stocks are expensive as the central bank’s continuous hike in interest rate to curb inflation will make equities less attractive for investors, relative to bonds.

The 10 year Treasury bond with a yield of 14.58 percent and earnings yields on NGXASI index of 0.096 percent (indicative of a P/E of 10.38x) gives a BEER ratio of 1.50, according to MoneyCentral calculations.

The bond equity earnings yield ratio (BEER) is a way investors can use bond yields to estimate the direction of the stock market. The ratio is determined by dividing the yield of a government bond by the current earnings yield of a stock or stock benchmark.

A ratio greater than 1.0 indicates the stock market is overvalued, while a rating of under 1.0 suggests stocks are undervalued.

The significant reason rising borrowing cost has not yet resulted in stock market turbulence is because of the equity rally since June, as investors applauded president Bola Ahmed Tinubu’s reforms.

However, a red-hot inflation and spiraling interest expense in the books of firms means investors will start to dump stocks for safe haven assets such as bonds.

“An aggressive tightening comes as equity valuation is close to being rich,” said Abiola Rasaq, former Economist and Head, Investor Relations For United Bank for Africa (UBA) Plc.