JSE headline P/E highly misleading: Part ONE

26 July 2016 | Willem le Roux & Ian Stiglingh
 


Further to the last VIEWS article published by PowerStocks Research (Declining Market Breadth an unhealthy sign for JSE) as part of their 12-part "Signs of the Bear" series, we set out to put their hypothesis of "market skewness" to the test by examining the effect of the ’Big-5’ (NPN, SAB, CFR, BIL & BTI) on the FTSE/JSE Top40 Index since this bull market commenced in March 2009.

If you recall, PowerStocks Research used the Advance-Decline Line (AD-Line) of the JSE to point out that market breadth peaked in Dec 2013, the same time that the SARB Business Cycle peaked. The proposal presented was that the AD-Line has been declining determinedly ever since and that the JSE was being propped up by a few large caps at nose-bleed P/E’s, and that without these large caps, the JSE had probably peaked long ago and was potentially already in a bear market.

image1

The following table highlights the large caps in the Top40 index, their weighting in the Index and their respective price/earnings ratio (P/E’s). It confirms that many large caps are indeed at rich valuations.

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The below chart shows that the current Top-5 in the above list (the ’Big-5’) started their weighting domination campaign around September 2011 when the Rand started depreciating in earnest, no doubt due to their large dual-listed offshore earnings component and Rand-hedge status.

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It confirms there is indeed a domination of Top40 weighting by a handful (literally)of large caps, and that this domination is as recent as 3 years ago.

The below chart shows the Top40 P/E and the P/E of the Top40 excluding the Big-5 (NPN, SAB, CFR, BIL & BTI) as at end 2Q2106 (end of June 2016):

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It confirms the current rich valuation of the Top40 at P/E 21.7 is isolated to the Big-5 and that the Top40 excluding the Big-5 only has a PE of 15.85, confirming the hypothesis put forward by PowerStocks Research in their June 23rd article "JSE P/E’s in unchartered territory"that withoutthe Big-5, the J200 probably only has a PE of 16.

In PART-TWO we show you what the Total Return Index of the TOP-40 looks like versus the TOP-40 index excluding the Big-5. You will be surprised.To continue to this article go see PART-TWO

"Geek note" on our index construction methodology:

The FTSE/JSE Top 40 Index was reconstructed using quarterly constituent data and making adjustments for index changes and corporate actions. The index uses free float-adjusted market capitalization methodology to determine the weight of each share in the index. The weight of a stock in a free float-adjusted market capitalization weighted index equals its market-cap (shares in issue times share price) weight multiplied by a free-float adjustment factor (a number between 0 and 1 representing the fraction of shares that float freely).This same methodology is used to create a sub-index that contains a subset of the parent index’s constituents. Each constituent’s free-float adjusted market capitalization is used to calculate the weight of each constituent in the sub-index. The new index weighting combined with each constituent’s total return enables us to compute the total return for the sub-index, and compare this to the total return of the actual (parent) index.



Willem le Roux & Ian Stiglingh

Willem le Roux is a full time quantitative analyst, responsible for research of equities across all industries. Willem completed his degree in Mathematical Science in 2011, as well as an Honours degree in Financial Risk Management in 2012, both at the University of Stellenbosch. Willem has previously worked for MSCI and is currently a CFA candidate

Ian Stiglingh is a full time quantitative analyst, responsible for research of equities across all industries. Ian completed his degree in Mathematical Science in 2013 and his Honours degree in Financial Risk Management in 2014, both at the University of Stellenbosch. During his studies, Ian worked as an intern at Old Mutual Actuaries & Consultants as well as J.P. Morgan in Johannesburg, and is currently a CFA candidate


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