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Blog: 17 January 2017 (Is the overall JSE expensive? Well yes and no)
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In today's blog take a look at the overall PE ratio of all shares listed on the JSE. And ask whether the JSE overall is expensive or not.
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Is the overall JSE expensive or not
When someone ask's what a specific share or company is worth, your first response should be what someone else is willing to pay for it. Share prices are driven by two things. 1. Fear. 2. Greed. It's hardly ever driven by sound reasoning or reasonable expectations of future earnings and profitability of companies.
In today's global world in which technology makes the world even smaller and allows for easier movements across markets there is another factor that is contributing to share prices in bourses. The relative strength or weakness of local and foreign currencies. If a local currency is under pressure, it becomes cheaper for foreign buyers to buy shares in specific countries, and visa versa.
Suppose a share on the JSE costs R500, and the Rand/US dollar is R10/$1. This share would therefore cost $50 to a American buyer. Now lets say the South African Rand weakens to R10.50/$1. That same share that would have cost $50 now costs $47.62 just due to exchange rate weakness experienced by the Rand.
So this shows the exchange rate can have a big impact on the price of shares for foreign buyers. So how do we marry whether the JSE is expensive and what's the exchange rate got to do with it you ask. Well one of the main metrics used to determine whether a share or in fact the stock market as a whole is expensive is to use the earnings yield (inverse known as PE ratio). We will calculate a PE ratio for the JSE as a whole, and then calculate a exchange rate adjusted PE ratio for the JSE as a whole in order to include the impact of exchange rate movements on the JSE's PE. The graphic below shows the PE ratio of the JSE and the exchange rate adjusted PE ratio.
For graphical and interpretation purposes the following was done. For January 2007 the starting point is the same. From there on any movements in the Rand/Dollar exchange rate was then used to adjust the actual PE value of the JSE to get an effective "exchange rate adjusted PE ratio".
Now while looking at the PE ratio of the JSE one can see it is trading at levels not seen in this time span of January 2007 to October 2016. A PE ratio for the overall market of over 22 is relatively expensive, considering the fact that the average for the period in question is just over 16. Now if one looks at the dollar adjusted PE ratio, it is currently sitting at levels of around 11.8, while the average over the period is 12.6. So it is actually below the average levels of the dollar adjusted PE for the period in question. It is clear that while the market might look on the expensive side for South Africans, the significant exchange rate weakness that South Africa has experienced in recent years has made the South African market relatively cheaper for foreign buyers (in particular those buying in dollars).
Considering January 2007 was the base period with a PE ratio of 17.57, the PE ratio has increased by 29.93% over this period, while over the same period the dollar adjusted PE ratio has decreased by -33%.
So while local buyers might be thinking the South African stock exchange is pretty expensive, those sitting on the other side of the Atlantic finds our local market is now 33% cheaper compared to what they were paying in January 2007.
So yes the JSE is expensive. If you looking at the PE ratio in isolation, but when you start looking at the impact the exchange rate makes on it, and the fact that technology makes it easier for foreign buyers to buy shares locally, one starts to understand what is supporting stocks at these high PE multiples. And if you think foreigners do not make up a large part of trade on the JSE, think again. They make up around 37% of value traded on the JSE. See our article on this here : Foreign trade as % of JSE
Considering January 2007 was the base period with a PE ratio of 17.57, the PE ratio has increased by 29.93% over this period, while over the same period the dollar adjusted PE ratio has decreased by -33%.
So while local buyers might be thinking the South African stock exchange is pretty expensive, those sitting on the other side of the Atlantic finds our local market is now 33% cheaper compared to what they were paying in January 2007.
So yes the JSE is expensive. If you looking at the PE ratio in isolation, but when you start looking at the impact the exchange rate makes on it, and the fact that technology makes it easier for foreign buyers to buy shares locally, one starts to understand what is supporting stocks at these high PE multiples. And if you think foreigners do not make up a large part of trade on the JSE, think again. They make up around 37% of value traded on the JSE. See our article on this here : Foreign trade as % of JSE