Australia 200 – Trust the Numbers

I’ve lost count of the number of times I’ve said “the investment metrics for the Australian share market are compelling” over the last months. Despite the recent rises in share prices, I believe this remains the case. But rather than make the bald statement (again) here is the data:

Australia 200 Index – Price/Earnings and Dividend Yield

Source: Bloomberg

Care is required in interpreting this chart. The white line is the Australia 200 index itself – the scale is on the left hand side of the chart. The green line is the Price to Earnings (P/E)ratio – the price of all the shares in the index divided by the total earnings of those shares. The scale for this line is on the far right.  The blue line is the dividend yield (DY) – all of the dividends paid by the stocks in the index divided by their total price (near right scale). The dividends in question are estimated for the upcoming year.

First, the anomalies. The index level is of course a matter of historical fact. Hower, both the P/E and DY are distorted somewhat by a lag effect.

When share prices fell dramatically in 2008 the DY spiked higher, largely due to two effects. Some companies continued to pay 2007/2008 dividends at levels reflecting pre crash income, giving an elevated return on their much lower share price – a real effect for investors. However, the spike is also due to a lag as analysts revised their dividend estimates downwards only after companies started reporting impaired earnings.  It’s unlikely the true DY hit the 7.5% high shown on the chart.

A similar effect shows up in the P/E as the market rallied from March 2009. Analysts were sceptical that real operating conditions had improved, bearing in mind this was just six months after Lehman’s demise. As share prices roared ahead, and earnings estimates remained unchanged, the P/E blew out. Once again, this lag effect distorts the reality.

While recent events in the USA, China and Europe may see earnings revision, there is no earnings disruptive event like the GFC – giving more confidence in current readings.

The market P/E bounced from 12x to 14x with the market rally – above the 10x reading at the depths of the GFC but still below the long run average around 16x, and well below pre-GFC readings above 20x. To me, this means the market is still in “cheap” territory.

More compelling is the DY. Excluding the GFC spike distortion, the DY is at its highest level in more than ten years. Combined with lower interest rates, there is a strong argument that long term investors sitting on the sidelines are missing out not only on potential share price moves, but income right now.

Economist John Keynes famously said “markets can remain irrational longer than you or I can remain solvent”. Investors with the long view can collect after tax DY’s over 10% pa while waiting for markets to become rational again.

About michaelmccarthycmc

Chief Market Strategist - CMC Markets and Stockbroking Regular on ABC, BBC, Bloomberg, Channel TEN, CNBC, SBS and SKY
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9 Responses to Australia 200 – Trust the Numbers

  1. Tony says:

    DY,s are already being cut back and P/E,s are backward looking. Moving forward to reporting season we have already had many profit downgrades and even the company’s meeting expectations the outlook statements sound quite downbeat at best. Resource company’s are already at or near GFC lows. Mining services are all falling as work is expected to fall. Financial stocks specifically the banks are the stocks propping up the XJO but how long can that last with house prices falling people being laid off and consumers saving more and borrowing less. The governments responsible lending laws are reducing demand for credit and our banks are forecast to grow at between 2 to 6% over the next 2 years but any decline in these relatively low growth numbers could have martial effect on there share prices and the XJO
    Sorry to be a bear but i cannot see how the index will push on higher let alone get to the forcast 4500/4800

    • michaelmccarthycmc says:

      Thanks for your view Tony.
      The P/E’s used are forward estimates for the next twelve months. Where are you seeing DY’s being revised downwards?

      • Tony says:

        Hi Michael
        Confession season was but a distant memory now, but from memory and looking forward the biggest adjustments to DY’s were Retailer’s, Media and Materials. The financial stocks have held up well so far, but we will have to see how long that lasts.

      • michaelmccarthycmc says:

        Spot on with retailers and and media – most remain under pressure. Market action at the moment poinst to the banks and Telstra as the focus for dividend oriented investors

  2. Stephen2615 says:

    I bought some ETF’s in April last year and they are still down 13.23% (5.51% over 12 months). Their recent dividend was pathetic as well as not franked. The last twelve months show that the market is only down 6.63%. Do people have short memories when it comes to market performance? With the normal miserable market movement in the second half of the year, I would be happy to have the ASX 200 hit the 4400 mark by Christmas. The interesting thing recently is how the ASX 200 is catching up with the All Ords. That must be a rather profound statement regarding how much is being made in the market these days and its not small cap. I am looking forward to what the dividend yields will be after this earning season. Imagine BHP doubling their lack lustre dividend for this next season and what impact that would have on the overall market?

    • michaelmccarthycmc says:

      Agree Stephen – dividends are a focus point for investors at the moment – especially those with an investment time frame of twelve months or more.

  3. Stephen2615 says:

    Michael, did you notice the symmetry of the dividend yield and ASX200 from about Feb 2008? If you remove the green line, it becomes apparent that there is a “line” where the dividends and ASX 200 are equidistant. The imaginary line does a good job of normalising the two lines. I know you like technical analysis much more than I do so what do you make of that? It strikes me as being interesting as it generally points to yields of about 4.9% and the 200 being 4450 by Christmas. Spooky if you ask me.

    • michaelmccarthycmc says:

      Interesting observation – particularly since December 2011. Have some concerns that it may be a co-incidence of overlay.

  4. Tired says:

    The actual dividend payments aren’t varying much in comparison to the big changes in ASX200 price. So the changes in the ratio between them (the Dividend Yield) are mostly reflecting the price changes.

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