Quick Bites | Where Do ASX Valuations Sit?

We have enjoyed 3 consecutive years of good returns from the ASX, clustered around the long term average. The chart below is sourced from the always excellent Ashley Owens of Owens Analytics. It shows calendar year nominal returns (capital gains + dividends): positive returns constitute 79% of years, negative returns 21% of years, with the average return of +10.4% (over the last 126 years).

Source: Owen Analytics

Following 3 years of good returns, but not a whole lot of earnings growth over that period, where do valuations sit? Let’s turn to Martin Crabb at Shaw and Partners for some great charts.

The following chart shows the forecast “Total Shareholder Return” of the market as calculated by Martin, based on an assumed reversion to long term average multiples. He expects the TSR to be 7.23%, comprising 3.24% dividend yield and 3.99% capital gain. Companies are paying out 59.4% of earnings. This is not a “hard forecast” but rather should be seen as indicative of where market valuations are sitting at a given point in time, and given the earnings per share expectations of market analysts.

“Fair value” represents a judgement of where the market could be trading were it aligned to longer term averages (the orange line), “15% TSR” is where the index needs to trade to deliver a total shareholder return of 15% (the grey line), and “Index level” is where the ASX 100 is actually trading (the black line).

Source: Shaw and Partners

The following chart shows where the forecast PE has traded historically. The 12m forward PE of the S&P/ASX 100 index is at 18.5x and EPS forecasts are starting to be upgraded.

Typically, over the last 15 years or so, the market has traded at around 14.5x forward earnings. This means that at the present time, with the forward PE sitting around 18.5x, the market is more expensive than usual. But it is not as expensive as it was a couple of months ago, when it traded briefly above a PE multiple of 20x forward earnings.

If earnings exceed expectations, then the PE multiple will decline, meaning that the market will be less expensive. With spot commodity prices strong, the materials sector could see strong upward earnings revisions.

Source: Shaw and Partners

Of course, it makes sense to dis-aggregate the market into its major components to identify which sectors are priced expensively, and which sectors look relatively cheap. This will usually reflect expectations of where earnings growth is forecast to be strong or weak in coming years.

Source: Shaw and Partners