As we’ve said before, sensible investors pay close attention to valuation metrics. But valuations in themselves are seldom a good guide to market performance – except over the long term. In other words, cheap markets can remain cheap, and expensive markets can remain expensive, for significant periods. In addition, valuations of an index will hide or obscure important details across sectoral differences. Nevertheless, despite limitations, being aware of valuations is often integral to being a successful investor.
The following charts are gratefully drawn from Martin Crabb at Shaw and Partners, published on 5 April 2024.
At present, the ASX 100 looks reasonably fully valued, and according to the Shaw valuation model below, is offering a lean total shareholder return (TSR) of 4.78% over the next 12 months (based on an expected dividend yield of 3.64% and 1.14% appreciation to target prices). Buying into the ASX 100 (the orange line) when it is below the 15% TSR level (the grey line), historically has yielded strong returns. Buying the ASX 100 when the orange line is above “Fair Value” (the black line) as calculated by Shaws, has been less rewarding.
Source: Shaw and Partners
Where is the ASX 100 on a forward price-earnings (PE) ratio basis?
We see in the chart below that the average PE for the market on a prospective basis has been around 15x over the last 20 years. At present, it is at 17x, indicating it is a little pricey, however, there have been times where the market has traded on higher multiples e.g. in 2020, when it traded above 19x. Also, this chart could change materially if earnings expectations are upgraded – for example, if commodity prices rise and the AUD remains depressed, we could see an upgrade in earnings expectations for the resources sector.
Source: Shaw and Partners
In aggregate, ASX 100 company profits are expected to flatline for the next year or so, but that could change quite quickly if fundamental market conditions change.
Source: Shaw and Partners
As noted above, looking at the broad index can be less than useful if it obscures what is occurring in different sectors. If we decompose the market into broad industry groups, it provides a more detailed view. Note how highly rated the “Overseas Growth” sector is; banks are presently trading on a higher multiple than the index (which is unusual and indicates banks are expensive); and Resources are the cheapest sector (at 12.9x) as identified in the table below.
Source: Shaw and Partners
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