Top-performing stocks Macquarie Group and Harvey Norman are two companies with share prices that have run hard in 2015 but may still be attractive to investors who don’t want to overpay in what is widely regarded as an expensive equity market.
That’s because, looking at current expectations around profitability versus mid-cycle trends, they still appear compelling, according to Citigroup equity strategist Tony Brennan.
The price-earnings (PE) ratio for the ASX 200 is currently at 15.6 times the value of forecast earnings - the highest since the post-crisis upgrade cycle. The price-to-book, or net assets, ratio is only at 2 times compared to 3.2 times at the peak of the commodity cycle. This was the case in almost all major markets except the United States, a fact which reflects negatively on Wall Street’s ability to sustain current levels.
By approximating a “mid-cycle” return-on-equity figure, the broker found there is still some value around - even, in some cases, in companies that have outperformed.
The stocks Citigroup believes “still look reasonable value” are Macquarie, Lend Lease, Mirvac Group, Harvey Norman, Incitec Pivot and IOOF Holdings. Macquarie, for example, is priced at 12.6 times fiscal 2016 earnings by adjusting for its estimated mid-cycle return on equity. That compares with 15.2 times 2016 earnings on an unadjusted basis.
Macquarie shares are up 36 per cent so far in 2015.
Harvey Norman’s 2015-16 mid-cycle adjusted PE is 14.8 times; currently it is trading on 17 times. The retailer’s shares are up 33 per cent.
Investors prepared to bet on “potential turnarounds or recovery stocks” should consider QBE Insurance Group, Woolworths, Orica, Fletcher Building and Metcash, the broker found. These had “moderate” price to mid-cycle earnings ratios.
To approximate mid-cycle earnings, the broker used return on equity over 10 years.
However, mergers and acquisitions can distort this, and by looking at pre- and post-acquisition return on equity, Mr Brennan found some companies had “high earnings on existing assets relative to the past”, indicating there was not a great prospect to lift earnings further. Profitability usually rises after a deal.
“One might perhaps be wary when assets are currently earning close to as well as they have at any time in the past decade … especially where PEs are also relatively high,” Mr Brennan said in his report.
Stocks in this category are Westpac, Wesfarmers, Amcor, APA Group, ASX, Computershare, Bendigo and Adelaide Bank, Bank of Queensland, Ansell and Primary Health Care.
For example, Wesfarmers’ mid-cycle return on equity, straddling the financial crisis between fiscal years 2004 and 2013, was 7.3 per cent. It is now at 9.2 per cent and forecast to hit 10.5 per cent in 2015-16.
Wesfarmers’ adjusted 2015-16 PE is therefore 26.5 times. It is only 18.3 times on the conventional unadjusted measure.
Amcor in 2015-16 is close to achieving double what it was returning over the historical period. Its adjusted PE soars to 37.5 times compared with 18.7 times unadjusted on current prices.
By: Vesna Poljak
This story originally appeared at www.afr.com
Research: TheBestReviewer
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