Keep some powder dry but be wary of commodity stocks. Picture: Eriko Sugita, Reuters.
Keep some powder dry but be wary of commodity stocks. Picture: Eriko Sugita, Reuters.

Defensive stocks favoured, be wary of resources

By Ryk de Klerk Time of article published Oct 11, 2021

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Ryk de Klerk

WHERE does the opportunity lie in South African stocks? Industrial stocks, resources or financials?

I was taught that a company’s earnings growth relative to other listed companies drives the company’s price growth relative to other listed companies and the equity market as such.

Mr Market’s view on the future prospects of a company relative to the market or other companies is reflected in the company’s rating as measured by the company’s earnings yield or inversely price-to- earnings ratio (PE) relative to the market.

The same is applicable to the main sectors of the stock exchange and the underlying industries.

It is impossible to even try to attempt to do in-depth analysis of companies to forecast future results and therefore earnings of a myriad of listed companies.

Therefore, I use consensus forecasts of stockbroking firms which research listed shares and calculated by data feed providers such as Iress.

However, consensus forecasts will differ as the data feed providers use different stockbrokers and other third-party analysts.

I use the constituents and their weights in the Satrix SWIX ETF (exchange-traded fund) to calculate the future earnings and earnings yields for the main sectors of the stock exchange and the underlying industries.

The ETF tracks the FTSE/JSE Shareholder Weighted Top 40 Index as closely as possible.

In my opinion the index is research-friendly and representative of the equity market in South Africa and consensus forecasts are available for the constituents.

The index includes the largest 40 companies listed on the JSE, ranked by SWIX net market cap. SWIX stands for Shareholder Weighted Index and refers to the proportion of the company’s shares held on the South African share register.

Consensus forecasts of 90 percent of the market capitalisation of the Satrix SWIX ETF were available, of which 7.8 percent was attributable to lack of forecasts for Prosus.

Naspers’s weight was upped by Prosus’s weight and the final results were scaled up to 100 percent from 98 percent (including Prosus).

I assumed that earnings for a company’s financial year would be split 50:50 for the first and final 6 months of the year. That is, except where earnings for the first 6 months of the current financial year has been declared.

In that case, the earnings for the second half would be the consensus estimate for the current year minus that of the first six months. The analysis of the rolling 12-month earnings was done through end-June 2023.

After plugging in the latest consensus forecasts, my model indicates that the general feeling in the market is that earnings in the industrial sector (index weight of about 48 percent) by June 2023 could be 35 percent higher than today at an annualised growth rate of about 19 percent.

Based on consensus forecasts, earnings in the financial sector could rise by 47 percent over the same period or at an annualised growth rate of 24 percent.

In sharp contrast, Mr Market’s view is that we are now past peak-cycle earnings in the resources sector. My calculations indicate that the market is anticipating a 10 percent contraction in earnings.

Based on consensus forecasts, the FTSE/JSE SWIX Top 40 could deliver earnings growth of 26 percent through June 2023 at an annualised growth rate of 14 percent.

So, just from an earnings growth point of view, the industrial and financial sectors are the place to be while a significant underweight position in resources seems justified.

The flip side of the coin is how much of the good news (strong earnings growth) is already priced-in in industrials and financials. Yes, how much are you paying for growth?

Also, has Mr Market overreacted during the slump in some commodity prices or does he know something unknown to the analysts?

In light of the apparent linear relationship between my calculated consensus earnings growth forecasts for the JSE sub-sectors or industries and the current rolling 12-month earnings yields of the industries, one gets an idea to what extent an industry may be under- or overpriced.

Remember that various factors are at play at any given moment that could impact on the ratings of the industries. Black Swan events are becoming more regular and so, the recoveries after the events.

Also bear in mind that the consensus forecasts are dynamic. Analysts may change their forecasts for a specific company overnight or change their views on the markets. Forecasts for specific shares and industries may turn out to be overly pessimistic or overly optimistic.

Forecasts may vary widely and the consensus is effectively just an average of the forecasts. Collectively, stockbroker analysts are not Mr Market.

In my opinion, defensive stocks are currently favoured by Mr Market but some industries seem to offer value. Keep some powder dry but be wary of commodity stocks.

Graph: Supplied
Graph: Supplied

Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment advisor for advice. Past performance is no guarantee of future results.

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