SPOTLIGHT: Stock market: can it get ‘cheaper’?
Sometimes we find that shops offer a "once in a lifetime" 10% discount and when you walk past this very store a couple of weeks later, a "25% discount" is offered.
I RECENTLY read an article by Schalk Louw (PSG), and with courtesy to him, I wish to use the researched information to present it in a digestible way to the readers of Bosveld.
Sometimes we find that shops offer a “once in a lifetime” 10% discount and when you walk past this very store a couple of weeks later, a “25% discount” is offered.
The fact is that those who took the chance and waited got those items for much cheaper.
The other side of the blade is just as sharp, however, because if you had waited for the 10% discount to pass in the hopes of a bigger discount, you would have missed out completely had this discount not realised.
Equity investors worldwide are now faced with the same choice with regard to filling up their investment baskets. Since August 2014 , the stock exchange has lost nearly 10% of its value, leaving the market at the same levels as at end 2013.
Is this the buying opportunity that investors with lots of cash have been waiting for, or should they take a chance on a possible larger “discount”? Before we try to answer this, we need to explain roughly how to determine whether the market is really trading at a “discount”.
A very popular benchmark that can be used to determine how cheap or how expensive a share is, is the historical price earnings ratio (PE).
The PE is the relation between the share price and the company’s earnings (profits). It is calculated by dividing the share price by the company’s last reported earnings (usually at year-end or half year-end).
The PE usually moves in the same direction as the share price.
Let’s say that Share A is trading at R10 and the most recent earning per share (EPS) is R2. The PE would be 5 (10÷2), or 5 times. If Share A’s price was to rise to R12, the PE would rise to 6.
If the company had increased its earnings by 25%, the EPS would rise to R2,50.
If the share price still traded at R12, the PE would then drop to 4.8. This gives us a fairly good indication of just how cheap a share really is.
The average PE of the FTE/JSE All Share Index since 1995, was 14.7 times.
That means that at the recent 19 times levels, we definitely traded on the more “expensive” side.
Furthermore, at our current 16 times levels, we are definitely trading cheaper, but we have not yet necessarily reached the “once in a lifetime” trading opportunity levels, especially if we take into account how many times during the past four years (after the great correction of 2008) we fell below the 13 times levels.
Louw says he can’t see any fundamental reasons why we should fall that far again, but should it happen now, this market could very well be purchased at that proverbial 25% discount (compared to end 2013).
Should we then stay away from shares for the time being?
This answer will differ from individual to individual, and will depend on their respective investment horizons.
Within the stock market there will obviously be shares trading at a larger “discount” than others. For those looking for such opportunities, Louw recommends a look at shares like Barloworld (current 10.5 PE vs historical average of 16.3 times), Billiton (11.2 PE vs historical 15 times), Mondi PLC (12.9 PE vs historical 14.7 times) and Sasol (9.1 PE vs historical 10.86).
In conclusion, it can be said for those who are currently invested in shares or equity funds, this surely marks uncertain times.
The reality, however, is that these movements are as natural as any end of season sale. The key is to keep your emotions at bay and invest your hard-earned capital in well-managed, good quality companies and funds!
Regards till next time.
Koos de Wet
* Koos de Wet is a Financial Planner at PSG Wealth and a member of the Fiduciary Institute of South-Africa. Readers can contact him at 015 491 2020 / 082 881 4672 or psgk@mweb.co.za
