Demanding or demeaning?

The price:earnings ratio table is a great slab of information to mull over in quiet moments.

There are just so many startling and surprising rankings you’re bound to go fluttering through annual reports and old Sens announcements to research what could be “special” opportunities.

However, the p:e ratio – which, in fact, is a multiple rather than a ratio – is one of the most misunderstood and misused investment measures.

The old adage applied to p:es was that the multiple – whether it be 10 times or 15 times – meant an investor would need 10 or 15 years to earn back his investment if earnings stayed the same every year.

But that’s dangerously simplistic.

Old news

Investors need to understand from the outset the multiples presented on share statistic pages are “historic” measures.

For example, if Dingbat Holdings – which earned 20c/share in the year to end-June 2009 – is trading at 160c on the JSE then the share is trading at a historical earnings multiple of eight times.

That might seem a reasonable price to pay for shares in a company that manufactures SA’s best selling Dingbats.

But would it be a reasonable price if Dingbat – caught off guard by the beach bat craze – was likely to see earnings drop to 4c/share in the year to end-June 2010.

That would put Dingbat on a “forward” earnings multiple of 40 times – making the share a very expensive proposition at 160c.

The opposite, of course, would be true if Dingbat were successful in applying its dingbat mouldings to make flame and grease resistant braai chop-flippers.

With new revenue streams, earnings for the financial year to end-June 2010 could be as high as 40c/share – putting Dingbat Holdings on a rather undemanding forward earnings multiple of four times.

So the point we’re trying to make is that the historic earnings multiple must be seen in context of future performance.

The rankings

Turning to our rankings, we have a classic example in “top” ranked Keaton Energy – which held an astounding earnings multiple of more than 160 times.

Keaton is a coal exploration company that – as it happens – earned a small profit (3.4c/share to be precise) in the year to end-June from its invested funds (probably cash).

Keaton’s share price – around 620c at year-end 2009 – is certainly not reflecting its historic earnings.

Rather, its shares are factoring in Keaton’s potential as a future coal producer – which, judging by the share price, still holds much promise.

Then there are also the “better days ahead” shares, where demanding multiples are indicative of market expectations of improved profit performances.

Rankings that (hopefully) fall into that category include packaging giant Nampak (no pressure, Mr Marshall!) on a multiple of 20 times, gold miner Harmony (33.5 times) and furniture retailer JD Group (almost 100 times).

Expectations for Harmony have at least been toned down, the share was on a multiple of more than 70 times in last year’s Top 200 rankings.

It’s interesting to note – talking about expectations for better days ahead – that in last year’s Top 200 rankings transport conglomerate Super Group was ranked near the top of the p:e table with a multiple of more than 40 times.

This year Super Group is off the table, which shows perhaps the market’s faith was misplaced.

Naturally, there’s also the contention companies with long track records of growth or with superior growth strategies should rightfully be accorded premium ratings.

Bear in mind

A number of examples support that contention, including media giant Naspers (19 times), robust mining conglomerate BHP Billiton (923 times), hotel group City Lodge (19 times) and slick hospitals group Medi-Clinic (20 times).

On the other hand, we have to marvel at the plethora of quality companies near the bottom of this survey trading at undemanding multiples.

Take Remgro (6.8 times), as well as Steinhoff, Hudaco, Lewis, Richemont and Group 5 (all trading at multiples of less than six times).

There are also some stunning contrasts. Small packaging group Bowler Metcalf, which in more than 20 years of being listed hasn’t reported a drop in profits, is accorded a p:e multiple of just over six times.

Larger packager Astrapak, which can’t claim the same consistency in profit growth, gets a superior market rating of more than nine times.

In the retail sector, Shoprite – which appears to be more popular with asset managers – traded at a earnings multiple of 14 times, while Pick n Pay traded at 15.5 times.

Woolies, which sell both groceries and fashions, finished 2009 on multiple of 11 times.

Afrimat, which has certainly been one of the better new listings in the building supplies sector, carries a multiple of just five times.

By contrast, the more brittle Alert Steel trades at a historical multiple of around 35 times.

 - Finweek

To view the p:e Table, click here