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This reporting season has seen some spectacular losses and the outlook for many companies is far from exciting. But on balance Australian companies actually shaped up better than you might think, and certainly much better than their overseas counterparts.
First half results revealed that corporate revenues rose by over 16% and almost 24% if you exclude financials. On an earnings per share basis, non-financials saw their earnings per share drop by only 6% compared with the previous corresponding period. The consensus forecast for full year results is for a 17% decline in earnings in FY09, while full year results in FY10 are expected to show a 4% rise.
These figures are nothing to get excited about but they do point to the fact that share prices may have dropped by more than what is justifiable. If prices drop by more than earnings, we see a fall in the Price Earnings ratio, which reveal that valuations are becoming much more attractive.
The long term PE of the Australian market is approximately 16. Given the recent drop in capital value and the less severe drop in earnings, the average PE of the market is currently around 8. Now a drop in earnings and the expectation for lower earnings to come clearly validate the depreciation in share prices but, according to the PE ratio, things may have dropped too far.
How is it that the market has not accounted for this? This is best explained by the high levels of uncertainty and plummeting levels of investor confidence. Until we start to see these factors improve, share values are unlikely to show any significant turnaround. But for those investors who have a reasonable investment time frame, say at least 3 years, current valuations provide a powerful incentive to pick up some undervalued stocks.
2009 is likely to be a very tough period for the economy, both here and abroad. But the consensus view at this stage is that we should start to see things improve as early as next year. Even if it takes a year or two longer, the fact is that things WILL improve, and as soon as the market starts to perceive an improved outlook we are likely to see a solid and rapid increase in share prices. Of course it could take a while before we see the market carve out new record levels, but that doesn’t change the fact that we will see a significant move away from current levels.
Income investors have an added incentive to take positions now, because while share prices have dropped around 50% from the high, current expectations are that full year dividends will drop by around 20%. That means that current yields are significantly above the long term average. Indeed, the average yield of stocks in the All Ordinaries is currently around 7%, the highest it’s been in over 35 years!
Investors have good reason to be cautious at present, but that doesn’t mean we should be irrationally fearful. An objective appraisal of recent figures and forecasts show that although things have deteriorated, share prices may have overreacted. From a longer term perspective, this represents a rare and exciting opportunity.
Make the markets work for you
Andrew Page
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