Surge poses question of value
The forward price-to-earnings ratio - which uses market value per share over earnings forecasts per share - for the benchmark S&P/ASX 200 over the past 12 months has run at levels not seen since the global financial crisis.
While down from this year's high, the market is trading on a forward PE ratio of 15.4, above the five-year average of 13.4.
Credit Suisse analyst Damien Boey said investors should be wary of a false bottoming out in the earnings cycle.
"If you extrapolate a little bit forward, a China slowdown would probably mean commodity prices fall a little bit and some sort of domestic slowdown, which may have an effect on the ability of our economy to generate credit and money supply growth," he said.
Mr Boey said he expected earnings to fall about 8 per cent.
Forward earnings per share for the ASX 200 have increased 15.6 per cent in the past three months, sitting at $341.66, while the market has jumped 13.2 per cent. "If you believe that market EPS could fall from here, then the market is very expensive," he said.
Macquarie Private Wealth division director Martin Lakos said while the market was expensive, he believed the outlook for Australian companies was more positive. Mr Lakos said earnings growth for the last financial year was near expectations, down 3.7 per cent. "The forecast for 2014 is a positive 16 per cent and 2015 11.5 per cent," he said.
"It's not stellar growth but it's reasonably good recovery."
Mr Lakos said much of this growth is predicted to come from the resources sector.
Mining stocks have had a rough year, falling 26.2 per cent from their 2013 high before bottoming out in June. They have since recovered 18.4 per cent but are still down 12.7 per cent from this year's peak. The forward PE ratio for the resources sector is at 13.4, near its five-year average of 13.2. Mr Lakos said the resources sector, which spent billions of dollars putting infrastructure in place, could now produce larger volumes, albeit at lower commodity prices, which would result in high profitability.
"These companies, BHP and Rio in particular, have got a higher focus on total shareholder return," he said. "From the strong cash flows that come out of this, we're expecting higher dividends from the resources sector."
The US Federal Reserve's decision last week to keep its $US85 billion-a-month bond-buying program in full will also have implications for the Australian sharemarket. Mr Boey said the decision to put tapering on hold was effectively a de-rating of the US economy.
"There is a re-rating of emerging markets relative to developed markets and Australia, coincidently, is caught right in between all that tension," he said.
On the Australian sharemarket, Mr Boey said he expected emerging market-driven exposures and bond proxies to hold up but said everything related to developed markets may underperform.
Frequently Asked Questions about this Article…
The article says the S&P/ASX 200 is trading on a forward price-to-earnings (PE) ratio of 15.4, which is above its five-year average of 13.4 and at levels not seen since the global financial crisis. Some analysts, like Credit Suisse's Damien Boey, warn that if earnings fall (he expects about an 8% drop) the market could look expensive, while others see a more positive earnings recovery ahead. That mix of views has driven the debate about whether the market is overcooked.
Forward PE measures current market value per share divided by forecast earnings per share. According to the article, the ASX 200’s forward PE is 15.4 versus a five-year average of 13.4, which suggests valuations are richer than recent history. For everyday investors, a higher forward PE can signal that the market is pricing in earnings growth — and makes future earnings downgrades or disappointment more important for share prices.
The article reports forward earnings per share (EPS) for the ASX 200 rose 15.6% in the past three months to $341.66, while the market jumped 13.2% in the same period. Credit Suisse’s Damien Boey expects overall earnings to fall around 8% if conditions weaken, whereas Macquarie Private Wealth’s Martin Lakos cites forecasts of +16% for 2014 and +11.5% for 2015, reflecting differing analyst views on the earnings outlook.
Mining stocks fell about 26.2% from their 2013 high before bottoming in June, then recovered 18.4% but remained 12.7% below this year’s peak. The resources sector’s forward PE sits at 13.4, near its five-year average of 13.2. The article notes analysts expect the sector to produce larger volumes after heavy infrastructure investment, which — even at lower commodity prices — could lead to strong cash flows and higher profitability over time.
The article quotes analysts saying companies such as BHP and Rio Tinto have shifted focus toward total shareholder return. With stronger cash flows expected from higher volumes in the resources sector, analysts anticipate the sector could pay higher dividends — though actual payouts depend on company boards and future commodity and earnings conditions.
The Fed’s choice to keep its US$85 billion-a-month bond-buying program intact was described in the article as a de-rating of the US economy. Credit Suisse’s Damien Boey said this creates a re-rating between emerging and developed markets and leaves Australia “caught in between.” As a result, emerging-market-driven exposures and bond-proxy stocks in Australia may hold up better, while assets tied more directly to developed-market strength could underperform.
Macquarie’s Martin Lakos is quoted saying much of the predicted earnings growth is expected to come from the resources sector. After significant capital spending to build infrastructure, those companies may be able to produce larger volumes — supporting earnings recovery even if commodity prices remain lower than past peaks.
Based on the article, investors should monitor the ASX 200’s forward PE relative to its historical averages, trends in forward EPS (which recently rose but could reverse), and external risks such as a China slowdown that could push commodity prices lower. Also watch sector differences — resources may recover differently to developed-market exposures — and central bank moves like the Fed’s decision on tapering that can affect risk sentiment.
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