As we’ve often noted, Price Earnings (PE) ratios provide a useful but often incomplete picture of whether a market is cheap or expensive. For one thing, the PE is a multiple of consensus earnings forecasts, and those forecasts can be wrong. Indeed, if a recession hits, the earnings expectations are likely to be revised lower in a hurry. Secondly, investment returns are often highly dependent on movements in interest rates, as we all know.
That said, the PE ratio, with all its many limitations, still paints an interesting picture. Here are a couple of charts covering the ASX 100 index, sourced from Shaw and Partners, as of the end of May 2023. It shows the PE at 14.6 times, which is around the long-term average. The chart includes Shaw’s estimate of where “fair value” sits and implies that “Total Shareholder Return” anticipated over the next 12 months is at almost 15%.
Source: Shaw and Partners
Looking at the PE ratio over a much longer period (since 1937, or over 85 years):
Source: Shaw and Partners
At a glance, to my eye, the market tends to range mostly between 15x to 20x, apart from a few exceptions such as the very slow recovery from the 1973 oil price shock and subsequent long recession. But trying to time the market using an approach like this is likely to be fraught with missteps, and it is far better to concentrate one’s attention on individual companies and ascertain whether or not they represent good value and high quality based on fundamentals such as the experience of management, consistency of revenue and earnings, resilience of business model, soundness of balance sheet, and so on. Unfortunately in markets, there are seldom useful shortcuts!
Disclaimer: Clime Asset Management Pty Limited | AFSL 221146 | ABN 72 098 420 770. The information provided in this post is intended for general use only. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information contained therein. Please consider the relevant disclosure document/s before investing in one of our products. Investment in securities and other financial products involves risk. An investment in a financial product may have the potential for capital growth and income but may also carry the risk that the total return on the investment may be less than the amount contributed directly by the investor. Investors risk losing some or all of their capital invested. Past performance of financial products is not a reliable indicator of future performance or returns.
