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In 1988 investors strongly questioned Warren Buffett’s abilities when he decided to invest in Coca-Cola. The company’s intrinsic value at that stage totalled $9.2bn, while its market capitalisation totalled $14.8bn.
Buying shares this expensive didn’t form part of Buffett’s philosophy, or did it?
Without going into too much detail, he purchased 6.3% of this giant between 1988 and 1989, which made up 35% of the total Berkshire Hathaway portfolio.
His reason for buying these shares was simple: the group was under leadership of Rogerto Goizueta, and good management meant that the company succeeded in increasing its earnings on a consistent basis.
Buffett, therefore, didn’t value Coca-Cola based on its current value at that stage, but rather on the company’s expected growth.
According to his models, Coca-Cola’s intrinsic value totalled anything between $20.7bn (if the company managed to grow its earnings by 5% per year) and $48.3bn (if it managed to grow earnings by 15% per year).
As with most of his other investments, therefore, Buffett Coca-Cola purchased at a discount and the original investment of $1.023bn in 1989 grew to a whopping $11.6bn 10 years later.
When we turn to our local market, it’s hard to believe that somewhere in there, value like that of Coca-Cola for Buffett, may be hiding, especially when we’ve been told so many times that the market is currently inflated and that share prices are generally on the more expensive side.
Aside from the fact that local shares have experienced real negative growth over the past three years and five months, the FTSE/JSE All Share Index is still trading at a very high price-to-earnings ratio (P/E) of 20.5 times when compared to the 20-year average historical P/E of 15.2 times.
Even if we take the consensus forecasts of all analysts (according to Bloomberg) into consideration, the current 1-year expected P/E still stands in excess of 19 times.
I mentioned previously that unlike many experts, we shouldn’t exclude Naspers* from this ratio, because it makes up nearly 20% of our total index and should this share experience a correction, it most certainly won’t leave other shares unscathed.
When hunting for value like that of Coca-Cola in our local market, one should be absolutely sure that whatever you’re looking at isn’t a matter of the tail wagging the dog.
Naspers is currently trading at a P/E of 110 times, with Richemont (the share with the second largest weight in our local index) trading at a P/E of 34 times.
By removing these two shares, which when combined carry roughly 26% of the weight of our total index, from the FTSE/JSE All Share Index, the current 1-year expected PE drops to 15.3 times, which falls perfectly in line with the 20-year average P/E.
When we start to dig deeper to find quality shares that currently offer good value, things become much more interesting.
I specifically looked at companies that are under proven good management, that have low price earnings ratios, and that are trading at low relative share price-to-book values.
Based on these criteria, five companies that currently stand out as offering the best 1-year expected growth, are Anglo American, Coronation, Reinet, Remgro and Woolworths.
I do believe that these shares can be considered as possible additions to any personal share portfolio.
These five shares are currently trading at an average historical P/E of 11.9 times, and a 12-month expected average P/E of 10.4 times.
Despite the hardships these five shares have endured recently, Bloomberg consensus (which bears no guarantees for future performance) indicates that the expected average growth on these five shares for the next 12 months will amount to 15.2%, compared to 11.6% expected growth for the FTSE/JSE All Share Index.
For those who see our local stock market as a glass half filled with no growth, look again: after nearly four years of no real growth, now may be the time to seize good opportunities and view our local market from a different angle.
*finweek is a publication of Media24, a subsidiary of Naspers.
Schalk Louw is a portfolio manager at PSG Wealth.
