HOW MUCH ‘CHEAPER’ CAN THE STOCK MAR­KET GET?

Finweek English Edition - - FRONT PAGE - BY SCHALK LOUW Port­fo­lio man­ager at PSG Wealth ed­i­to­rial@fin­week.co.za

Iam amazed by the fact that although my daugh­ters are grow­ing older and, as a re­sult, want less and less to do with Mom and Dad, they still teach me a life les­son or two ev­ery day. At ages 15 and 16 re­spec­tively, they al­ready have a firm un­der­stand­ing of the con­cept of a dis­count. A few months ago, with win­ter barely be­gin­ning, I was told that there was a “once-in-a-life­time” 10% dis­count on all win­ter wear at their favourite cloth­ing store. I couldn’t help smil­ing when I hap­pened to walk past this very store ear­lier this week, only to see that there is now a 25% dis­count on all win­ter items.

The fact is that those who took the chance and waited now 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 the big­ger sale never ma­te­ri­alised.

Eq­uity in­vestors world­wide are now faced with the same choice with re­gard to f illing up their in­vest­ment bas­kets. Since Au­gust, the stock ex­change has lost nearly 8% of its value, leav­ing the mar­ket at the same lev­els as in Jan­uary this year. 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 I try to an­swer this, I’m go­ing to ex­plain roughly how to de­ter­mine whether the mar­ket is re­ally trad­ing at a dis­count.

A ver y pop­u­lar bench­mark t hat can be used to de­ter­mine how cheap or ex­pen­sive a share is, is the his­tor­i­cal price-earn­ings ra­tio (P/E). The P/E is the re­la­tion be­tween the share price and the com­pany’s earn­ings per share (prof­its). It is cal­cu­lated by di­vid­ing the share price by the com­pany’s last re­ported earn­ings per share (usu­ally at year-end or half yearend). The P/E usu­ally moves in the same di­rec­tion as the share price.

Let’s say that Share A is trad­ing at R10 and the most re­cent earn­ings per share (EPS) fig­ure is R2. The P/E would be 5 (R10 ÷ R2), or 5 times. If Share A’s price were to rise to R12, the P/E would rise to 6. If the com­pany in­creased its earn­ings by 25%, the EPS would rise to R2.50. If the share price still traded at R12, the P/E would then drop to 4.8. This gives us a fairly good in­di­ca­tion of just how cheap a share re­ally is.

Look­ing at the ac­com­pa­ny­ing graph, you will no­tice that the av­er­age P/E of the FTSE/ JSE All Share In­dex since 1995 was 14.8 times.

That means that at the cur­rent 17.7 times lev­els, we are def­i­nitely trad­ing on the more ex­pen­sive side and have not yet nec­es­sar­ily reached those “once-ina-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.

At this stage it may be dif­fi­cult to be­lieve that it will hap­pen in the near fu­ture, but with the eco­nomic cli­mate hav­ing changed as much as it did over the past year (higher in­ter­est rates, weaker rand, etc.), this mar­ket may very well be pur­chased at that prover­bial 25% dis­count (com­pared to end of 2014), should it move back to­wards the 13 times P/E.

So should we stay away from shares for the time be­ing? This an­swer will dif­fer from in­di­vid­ual to in­di­vid­ual, and will de­pend on their re­spec­tive in­vest­ment hori­zons.

It can be said, how­ever, that for those cur­rently in­vested in shares, these surely are un­cer­tain times. That be­ing said, how­ever, these move­ments are as nat­u­ral as ev­ery end-of-sea­son sale. The key is to keep your emo­tions away from your money and in­vest your hard-earned cap­i­tal in well-man­aged, high-qual­ity com­pa­nies.

SINCE AU­GUST, THE STOCK EX­CHANGE HAS LOST NEARLY 8% OF ITS VALUE, LEAV­ING THE MAR­KET AT THE SAME LEV­ELS AS IN JAN­UARY THIS YEAR.

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