The JSE earnings and dividend cycles – a May 2018 update. What the market may be telling us
The growth in reported JSE All Share Index earnings per share appear to have peaked. The year on year growth in earnings have fallen back from the 30% rate realised in late 2017 to the current rate of 10% realised by the May 2018 month end. Index dividends per JSE share were growing at a 20% annual rate at the May month end. A time series forecast of both earnings and dividends suggests that their growth will slow down to less than 5% in the next 12 months.
The resource companies listed on the JSE have grown their earnings and dividends more rapidly than the other sectors over the past year – off a lower base. Resource earnings in January 2017 were 34% down on earnings the year before, while All Share Index earnings were 15% lower in January 2017 than in January 2016.
We show some of the trends in sectoral earnings growth rates in figure 2 below. Industrial Index earnings were trending higher at a 19% a year rate by May 2018, Banks at a 7% rate while the General Retail Index earnings per share were declining at a 3% rate. Resource earnings were trending at a 34% rate in May 2018 – though well down on the peaks of 80% growth realiised in late 2017.
When calculating an earnings cycle the base effects- what happened a year before – is important for current growth. It is much easier (more difficult) to realise high (low) rates of growth when growth was subdued (or buoyant) in the same month the year before. Perhaps it is more helpful when interpreting the performance of listed companies and the values attached to them to examine the level of rather reported earnings.
Perhaps even more illuminating about the state of play on the JSE would be to examine the level of earnings or dividends in constant prices, as we do in figure 3 below.
Real dividends have outpaced real earnings – they are now close to peak real dividends of 2014, while real earnings are still well below real earnings realised before the global financial crisis and recessions of 2009. This is surely a very sobering statistic- it shows that the real earnings front of the JSE have moved backwards since 2006.
The movement of the JSE since 2000 therefore appears to be better explained by dividends than earnings. Were it not for the stellar performance of Naspers, a play on Chinese internet firm Tencent the JSE All Share Index, in which Naspers has comprised an ever more important weight, would have fallen back.
It would appear that JSE-listed companies have performed better than the SA economy. They have accordingly returned relatively more cash to shareholders, presumably for want of investment opportunities. A corollary is that had they invested more of their cash in South Africa, the economy would have performed better. However it is unrealistic to expect capital expenditure of business enterprises to lead household spending (accounting for 60% of all spending in SA) that has remained consistently depressed by the standards of the past.
In figure 3 above we compare real JSE Index earnings and dividends with the real value of the JSE. The All Share Index seems better explained by the upward trend in real dividends than the sideways move in real earnings. We can confirm this by regression analysis. An equation that links the nominal value of the JSE All Share Index with the contemporaneous level of reported dividends and short term interest rates provides a good statistical fit. Indeed the current level of the JSE is almost precisely as would be predicted by this valuation model. When we add the rand value of emerging markets (EM) generally as an additional explanation of the level of the JSE – we get an even better fit. The R squared rises from 94% to 99% with all the explanatory variables attaining highly significant and plausible values.
This provides for the conclusion that the JSE may be slightly undervalued by the standards of the past, given the level of the EM benchmark that the JSE has lagged behind. Perhaps giving a degree of safety to the JSE at current levels. Yet as before, the strength of the JSE will depend upon the flow of dividends, interest rates, the value of the rand and the level of the EM benchmark that the JSE always tracks closely.
We could add as a further important influence the value of Information Technology stocks worldwide that Naspers will follow closely. Perhaps it is easier to be confident about the supportive role to be played by the EM benchmarks and the role of IT within them, than the benefits a stronger rand and accompanying lower interest rates could bring to the flow of dividends and earnings from the JSE All Share Index. The strong dollar and therefore the weaker rand and the more inflation that will follow it has become a headwind for the SA economy and the companies dependent on it. 5 June 2018