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During the past 12 months, we have heard that international markets were enjoying high tide, especially since the MSCI World Index grew by 17% in US dollar terms (up to the end of February 2018).
We also heard that our local market was enjoying high tide, thanks to growth of 17% in rand terms over the same period.
But while all things stayed happily afloat, it was only when we delved a little deeper, that it became clear that the largest portion of this (local) growth came from only one share.
For the past three years, we were told repeatedly that the FTSE/JSE All Share Index’s average price-to-earnings ratio (P/E) is trading at very high levels and that we should proceed with extreme caution.
Recently, however, experts indicated that the JSE’s historical average P/E of 19.3 times, excluding Naspers*, isn’t that expensive after all, and that it’s trading a lot closer to the 15-year average of 15.8 times.
Then, of course, we are also faced with other experts who argue that the P/E as a valuation tool is completely unreliable. So how do we go about determining if the JSE still offers value?
I decided to use two alternative valuation tools on individual shares in an attempt to find out if the local “tide” is really as high as they say it is.
Share prices relative to their net asset value (book value)
The price-to-book ratio (P/B) is determined by comparing the market value of a share with its book value.
The lower the P/B, the more undervalued the share. For those who want to point out that this ratio is more applicable to some JSE-listed companies than to others, I want to reassure you that I adjusted my formula somewhat.
I took each of the Top40 JSE shares and placed their current P/B relative to their five-year average P/B to get an idea of how over- or undervalued the Top 40 Index (which makes up 82% of the JSE) really is (compared with the last five-year average).
This calculation revealed that the Top40 Index’s P/B relative to its five-year average still appears to be “overvalued”.
Unlike the historical P/E, though, it’s only about 5% more expensive.
Intrinsic value
A more advanced method to do valuations is by calculating a company’s intrinsic value.
Long and complicated explanations aside, the intrinsic value of a company is determined by summing the discounted future income generated by the asset in order to obtain its present value.
Again, this valuation method cannot necessarily be applied 100% accurately to all companies listed on the JSE, but it still gives us a basic idea of how strongly over- or undervalued an asset is.
As with the P/B ratio, I placed the calculated intrinsic values of each of the Top40 shares individually as a percentage of their weight in the index to determine their status as over- or undervalued.
The results, contrary to the P/E and P/B ratios, showed that the Top40 Index is currently trading at a 2% discount relative to its intrinsic value.
When we take Naspers out of this calculation, things become quite interesting.
By taking Naspers out of the Top40 Index, this figure turns into a 17% discount relative to its intrinsic value.
Take note that all these valuations are based on historical values and that they bear absolutely no guarantees for future performances.
To conclude, although global markets are still labelled as “expensive”, things aren’t looking quite as overvalued locally, especially when we take Naspers out of the equation.
Schalk Louw is a portfolio manager at PSG Wealth.
*finweek is a publication of Media24, a subsidiary of Naspers.
