Valuations play an important role in equity markets. However, investors should not use them to determine the correct entry or exit times.
Equity investors acquire a share of future company profits. In order to determine the appropriate price of an equity, they need to assess the profit performance. This is not easy, as the consequences of market changes or innovations for the course of business are difficult to predict.
Markets therefore only react to extreme valuations. However, even this can be unreliable, as the dotcom bubble at the turn of the millennium showed. In the run-up to this, many investors forgot to check whether the price of an equity actually reflected a realistic development of future profits. As a result, the potential of many Internet startups was massively overestimated.
In the eyes of Swiss Life Asset Managers, such a scenario could be repeated again today in sectors such as electromobility and IT. While it considers valuation to be a useful tool for assessing the risks and rewards of an equity investment, investors should not use it for determining the best market entry or exit times.
