Market watchers are well aware that share prices on the JSE have run faster than earnings. The price over earnings multiples have increased to their highest levels since January 2000. Is this rerating of the market irrational exuberance as many fear or has it a more fundamental explanation?
The rerating of the market owes much to the increased values attached to the leading industrial companies listed on the JSE. Their values have been rising significantly faster than their earnings and are now trading at close to 24 times reported headline earnings per share.
By contrast, the prices of resource companies have held up much better than their earnings, which have declined significantly, but are clearly expected to recover strongly. Reported JSE Resource Index earnings per share are more than 22% below their levels of a year ago. Financial companies on the JSE have not rerated. Their price to earnings multiples remained largely unchanged and remain undemanding of earnings growth.
While the share prices of the major companies included in the JSE Industrial Index have risen faster than earnings, it is perhaps less apparent just how well these companies have performed on the earnings front. We show below the progress of JSE Industrial Index earnings per share since 2003 when these earnings first took off after a long period of stagnation, especially when measured in real terms.
Earnings grew very rapidly until interrupted by the Global Financial crisis of 2008-09. The decline in these earnings was modest and temporary and then resumed an upward path about as steep as that realised between 2004 and 2008. This observation needs emphasis. Despite what will be regarded as well below par global and SA economic growth since 2009, JSE Industrial Index earnings per share have been growing as rapidly as they did during the boom years of 2003-2008.
In the figure below, we convert recent industrial earnings growth into real terms. Real industrial earnings growth has averaged about 9% per annum, or 15% in nominal terms, with little sign to date of a slow-down in the pace of growth. Indeed the pace of growth appears to be remarkably stable as well as strong.
Investors, it may be concluded, are paying up, not only for earnings but for strong and stable earnings growth. The question to be answered therefore is not so much as to why the market has rerated JSE industrial earnings – they surely deserve such a rerating based on past performance – but whether or not the impressive consistent pace of earnings growth can be sustained. Future performance will depend not only on the capabilities of managers, who have proved capable of growing earnings and realising consistently high returns on shareholder capital employed in what have been tough times, but also on a recovery in the pace of SA and global economic growth.