INDUSTRY PERHAPS NEW WINNER
INVESTORS HAVE for a long time failed to give the necessary attention to industrial shares, the manufacturers of goods and even providers of services in South Africa. First, there was the glitter of financial shares – followed by the nearly perpendicular increase in the price of commodity shares. The strong rand, somewhere between US$1/R6 and US$1/R7 for a few years, also made things difficult for SA’s manufacturers.
Nevertheless, quite a long time ago – more than a year – things began going better and better with such shares. For the past 12 months the listed Satrix Indi, with its 25 leading industrial shares, has been doing better than the more illustrious Satrix Fini.
In fact, the graph of the Indi 25 versus the Fini 15 shows that from May 2007 things started moving clearly in favour of industrial shares. However, the prices of those shares have also been hard hit since August 2007 by the impending financial crisis, which has now developed into a real mess.
There are quite a few reasons why manufacturers and industrial shares may now be more attractive than financial shares and perhaps even resources. First, most of those companies have excellent balance sheets. Instead of borrowed capital there are large deposits. The balance sheets are almost too lazy. The value of the rand has weakened significantly over the past few months. Even on a trade-weighted average, SA manufacturers are suddenly enjoying the benefit of a devaluation of between 25% and 30% in the value of the rand and therefore imported goods to be competed against.
That’s also one of the few, if not the only, falls in the value of a currency that’s not directly linked with higher inflation and interest rates. That creates a particularly favourable climate for manufacturers, especially if the ongoing high infrastructure spending is also taken into account.
Currently, DIY investors won’t do badly by simply buying Satrix Indi. Investors who like to buy individual shares can make a selection from the list.
Rather than focusing on the usual earnings multiple and dividend yield of the individual shares, let’s look at the peg ratio. That’s a function of the current PE divided by the growth and it tells that any value of less than 100% – but especially less than 75% – is good.
Properly updated pegs of the financial sector aren’t yet readily available from McGregor BFA, as analysts are still hesitant about building the lower, if any, growth of bank profits into their calculations. But if a bank with an earnings multiple of eight warns its profit growth will only be 5%/year that translates to a peg of 160%, far higher than the upper limit of 100%.
Investors are advised to steer clear of the banks’ questionable promises and rather to look at the list of larger industries instead of financial shares. Smaller industrial shares – even pennystocks – with a market capitalisation of less than R1bn are still very much worth investing in. Small industries are in a completely different environment from small banks, which in any case no longer exist in SA.
Smaller companies in the industrial sector, many of which are now trading at PEs as low as four to five with good growth prospects, now offer excellent opportunities. Investors with a taste for smaller shares can now enjoy themselves in that sector in reasonable safety. However, keep well away from everything that’s small – and even nearly everything that’s big – in the financial sector.