Why I'm calling a buy on the JSE, even though many call it expensive

by , 22 September 2017
Why I'm calling a buy on the JSE, even though many call it expensive
“The JSE is too expensive, rather buy these offshore stocks”, if read this headline, and variations of it many times in the past year.

Yet, my Red Hot Penny Shares readers would've banked an average gain on shares we sold of 22.21% in 2016.

Whilst there are still calls to drop the JSE and put your money elsewhere I am optimistic.

I believe 2017 can be just as good, or better, than it was to me in 2016.

Let me explain…

Why the JSE isn’t nearly as expensive as it looks

 
Generally, investors believe a high PE ratio means expensive shares, or an expensive market.
 
Between December and the start of February the JSE was on a PE of around 23. The most expensive it’s been in decades.
 
Today the JSE’s All-Share Index is on a PE of 19.65, still high by most accounts.
 
But if you dig just a little deeper you’ll see that this isn’t a true account of what’s going on.
 
You see, Naspers is the largest share on the JSE. And because of the way index weightings are calculated the index is weighted by 13.83%.
 
So, with Naspers on a PE of 77, it makes the entire index look a lot more expensive than it should. Similarly, the second and third largest companies are also on high PE’s.
 
To see what the rest of the All-Share Index looked like I stripped out the three largest companies in the index, accounting for 29.55% of the index, even though there are 159 other shares in the index as well.
 
Ignoring these three shares puts the JSE on a much lower PE of only 15.97.
 
Suddenly not that overpriced any more. In fact, that’s very close to the long-term average for the JSE…
 

The economy will turn in 2017 – signalling now as a great buying opportunity

 
If you didn’t know, the PE ratio is the price of a share (or group of shares when we look at an index) divided by the profits made.
 
So when profits go up, and the share price stays constant, the PE ratio goes down and a share looks more ‘attractive’.
 
Considering I expect an improved GDP growth figure for South Africa in 2017, there’s a lot of room for companies to grow profits. That’s why I believe they are attractive.

Here are three reasons I believe we’ll see the economy recover in 2017:

  • The drought has come to an end. In 2016 South Africa had such a maize shortage – it needed to import more than 1.5 million tons of it, all because of the drought. But that’s set to change. According to Paul Makube, Senior Agricultural Economist at FNB, the 2017 crop is estimated to grow by 60%. That means at least 12 million tons of maize compared to the 2016 figure of 7.5 million tons.

    This isn’t only a positive for the agricultural sector. Sales of machinery and fertilizers will also benefit.
     
  • Declining car sales have stopped: January 2017's aggregate new vehicle sales at 50 333 units had registered a welcome, albeit modest, improvement of 1819 vehicles or a gain of 3.7% compared to the 48 514 vehicles sold in January 2016. This is the first month of growth in car sales after 14 months of straight decreases. Car sales aren’t just good for dealers and manufacturers. They also help transport companies and banks.
     
  • Inflation will come under control: When inflation is under control, interest rates stay steady or drop. I believe SA’s inflation is looking a lot better than 2016. There’s three reasons for this. The end of the drought means lower food inflation. The Rand has strengthened, which means cheaper imports. And lastly, the oil price is remaining steady, which means fuel prices will stay under control. This is a good sign for retail shares.
All in all I expect this year to be a much better one for businesses than 2016. That means profits will grow, and shares will become more attractive.
 
If you’re not yet buying shares you should. The JSE isn’t nearly as expensive as they say it is!
 
Here’s to unleashing real value
Francois Joubert

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