Beware the winning shares
When things have been looking up, we tend to throw caution to the wind and can often come off quite badly by basing future outcomes on current windfalls. Although there have been some ‘winners’ in our stock market, it would be wise to approach with cautio
amassive flood trapped a scorpion in a tree, fearing for his life as the water level continued to rise. Unfortunately he couldn’t swim, so in a panic he started calling for help. Moments later, a duck swam towards him and asked how he could help. “No, scorpion,” said the duck to the scorpion once the trapped creature had explained his problem, “I can’t let you ride on my back to safety. I know you too well. You will sting me.” But the scorpion promised the duck that he wouldn’t do him any harm and the duck let the scorpion climb on his back so he could be taken to safety. Just before they reached dry land, the scorpion broke his promise and stung the duck. As the bird started to sink, he turned and asked the scorpion, “But why did you sting me? If I die, so will you!” Right before disappearing below the water, the scorpion answered: “I’m sorry, but it’s just my nature!”
The monthly published figures on shares and unit trusts can easily place an investor in the scorpion’s shoes. It is in our nature to want to choose last year’s ‘winners’ in compiling our future investment portfolio.
Up until the end of October, our local stock market was up by 11.3% for 2015, and by a whopping 58% (17% per year) in the last three years. Within the JSE/FTSE All Share Index, shares such as Naspers*, Steinhoff and SABMiller seem irresistible, with returns of 260%, 191% and 129% respectively over the past three years (until the end of October). As investors, it is simply in our nature to be convinced that now is the time to buy.
The problem, however, is just as the prices of goods are pushed higher the closer we move towards Christmas, our stock market currently isn’t priced cheaply at all. On the contrary, the FTSE/JSE All Share Index’s historical price/earnings ratio (P/E) is at its highest in 20 years and the possibility of a correction now seems more likely than ever before.
Many investors may say that they have heard this from several experts since early last year, but it also has to be said that we were able to sustain these high P/Es in 2014 and 2015 without being stung by the proverbial scorpion. In 2014, company earnings (profits) on the FTSE/JSE All Share Index increased by 15% to 20% year-on-year, which could justify these high P/E levels. Our current year-on-year growth, however, is nowhere near those levels anymore. In fact, earnings are now 8% lower than they were a year ago, and in my opinion, this definitely doesn’t justify our current 20-year P/E level high. My findings may be based on historical figures, but with rising interest rates in South Africa – and a huge possibility of an interest rate hike in the USA this coming December – growth may be suppressed. I recommend that investors exercise extreme caution when it comes to trusting the ‘scorpion’ at this point.
By using an earnings-per-share model (as explained in my article published in the 3-9 April edition) and strictly applying its methods to our current situation, it would seem that our market would be fairly priced at around 40 300 points. This means that if we do experience a correction, we may see a decline of up to 27%. It may be in our nature to not want to miss out on the ‘winners’ in the stock market, but I urge investors to be careful of its extremely ‘poisonous sting’.
It would seem that our market would be fairly priced at around 40 300 points … if we do experience a correction, we may see a decline of up to 27%.