It is true there are some real risks within the economy and the stock market that should invite investor caution. However, there always is. They should not stop investors from looking for opportunities, and to the extent they are found, to invest appropriately. In the end, it is investor caution that gives rise to cautious expectations and cautious share prices.
Currently, the Australian market trades on reasonable valuation metrics, namely:
- a PE multiple of 15.5x the next 12 months earnings, which equates to an earning yield of approximately 6.5%;
- a dividend yield of 4.5%. This implies that only about 70% of earnings are paid out as dividends, leaving the remaining 30% to be reinvested back into the business for future growth. This dividend yield of 4.5% also comes with a level of franking credits. On a grossed up basis, which is the best measure when comparing the yields available on bonds and like assets, this yield equates to 6.0%;
- EPS growth of approximately 10%. Whilst this is very likely to be revised downward, there is at least some level of growth that augments the dividend yield. This earnings growth partly results from the reinvestment of retained earnings.
In the context of the low interest rate environment, and the relatively low returns available on other asset classes, these metrics appear quite attractive.
That’s not to say investors should buy equities complacently. There are some pockets of the Australian market that look quite risky. Earnings risk abounds. There are, however, some pockets in which we are finding quite attractive opportunities. In this respect, it pays to be selective and to focus on company fundamentals, and to favour high quality, strong growing companies with underestimated earnings power.
