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
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.