The ratio of the market value of equity to the GDP can both theo-
retically and empirically exceed 1. Equity valuation is a balance sheet
item, while the GDP is an annual flow. Many firms have capital that far
exceeds their annual sales, so it is not at all unusual for the value of an
economy’s capital to be greater than its output.
But more importantly, equity capital is only a part of total capital.
Both debt and equity finance the capital stock, and the ratio between
them changes over time. In the 1990s as interest rates fell, many firms re-
tired high-coupon bonds and reduced their leverage, a process called
deleveraging. Deleveraging increases the value of equity and decreases
the value of debt but leaves the total value of the firms unchanged. As
the market has risen, more firms have become public companies. This
will increase the market value of stocks even if the total value of firms,
public and private, remains unchanged.
Moreover, the ratio of the market capitalization to the GDP differs
widely among countries. Multinational firms might be headquartered in
a particular country while their sales span the globe. As international
trade increases, it should not be surprising if the market value of firms
deviates from the GDP of the country in which they are headquartered.
Table 7-1 shows that the market value of shares traded in Hong Kong are
over 600 percent of its GDP, while in Germany, Italy, and Japan the ratio
is less than 100 percent. The variation between countries results from
large differences in the leverage, the fraction of firms that are publicly
traded, and the international scope of the firms headquartered there.
One ratio that has very little meaning but is often seen in the press
is a time series of the ratio of a stock index such as the S&P 500 or the
Dow Jones Industrials to the GDP. Stock indexes report the average
prices of individual shares, not the total value of such shares that will
120 PART 2 Valuation, Style Investing, and Global Markets
TABLE 7–1
Summary Market Statistics for Various Countries as of February 2007: Market Value (MV) to Gross
Domestic Product (GDP); P-E Ratio; and Dividend Yield*Data for market value (MV)/GDP are for February 17, 2007.†
P-E and dividend yield are based on last 12 months of earnings and dividends.Statistic
MV/GDP*
P-E†
Div. Yld.†U.S.
136%
19.0
1.67%Japan
74%
24.1
0.97%Germany
53%
15.9
2.29%Britain
159%
18.9
3.54%Hong Kong
602%
14.9
2.78%Switzerland
270%
17.6
1.62%Italy
47%
14.8
3.53%