The quarterly earnings reporting season is now almost behind us. As we show below the deep trough in earnings in 2009, coinciding with the global recession, is now more than a year behind us. JSE All Share earnings per share since May 2009 (smoothed) have grown by nearly 40% with the growth in Resource Sector earnings leading the other sectors by a very large margin. Financial Sector earnings reported to date are barely ahead of where they were a year ago while JSE Resource Sector earnings have grown by nearly 80% with Industrial Sector earnings up by about 20% on a year before.
The Resource counters have clearly benefited from the recovery in commodity prices that has contributed also to the strength of the rand. The industrial companies have gained from the recovery in the global economy and the recovery in the SA economy where growth is pacing that of global growth. Industrial companies, especially the domestic retailers and distributors of goods and services with high import content, benefit form rand strength. The banks might ordinarily have been expected to benefit from rand strength and the lower interest rates that follow lower inflation led by rand strength. However the demands for bank credit have stalled at only marginally positive growth rates. Until house prices and demands for mortgage loans pick up momentum the growth in bank revenues will remain subdued.
We compare reported JSE earnings, so called trailing earnings, with what we describe as normalised earnings. Normalised earnings are estimated using a 10 year rolling time trend. Trailing earnings are catching up with normalised earnings. If the past is a guide to the future then there would appear to be considerable scope for further earnings upside. The underlying trend in earnings growth also suggests as much. If the underlying trend in All Share earnings is extrapolated, the prediction is growth in All Share earnings of 30%, to be reported in 12 months’ time, led by growth in JSE Resource earnings of over 60%. Clearly such a time series forecast would be vitiated by any sharp reversal in commodity prices.
These underlying trends may be regarded as encouraging of higher valuations on the JSE. As we also show the JSE All Share price to trailing earnings is just under 16 times while the price to normalised earnings ratio is of the order of a below average 14 times. Clearly for the market to move ahead normalised earnings will have to materialise and most important world markets will have to be supportive.
Earnings and dividends from companies listed on the developed equity markets have also recovered strongly from crisis depressed levels of 2009. S&P reported earnings per share in the first quarter of 2011 have recovered to over US$81 compared to the barely US$7 of mid 2009. S&P earnings and dividends per share are now nearly back to their record pre financial crisis record levels.
It makes no sense to attempt to normalise S&P earnings given their extraordinary recent collapse. Consensus forecasts expect US dollar 100 of S&P earnings per share by year end, to be reported in Q1 2012. When we normalise S&P dividends that were much less severely damaged we find that reported dividends are still trailing well behind normalised dividends.
The S&P at 1331 has recovered strongly and outpaced Emerging markets over the past six months as we had suggested it would. When we calculate a dividend discount model for the S&P, discounting trailing dividends by long term interest rates going back to 1980, we find the S&P to be 24% undervalued for trailing dividends and 32% undervalued for normalised dividends. We therefore continue to be of the view that the least demandingly valued of the equity markets is the S&P 500.
To view the graphs and tables referred to in the article, see Daily Ideas in todays Daily View: Daily View 31 May: With reporting season behind us, some room for comfort in current valuations