Stock Takes: The importance of p/e as 'equity tourists' pack their bags

Higher interest rates mean "equity tourists" are leaving the share market. Photo / File

As the sharemarket approaches bear territory, the way in which investors go about valuing stocks has come into sharper focus.

As things stand, the S&P/NZX50 index is just a few hundred points off fitting the definition of a bear market - a 20 per cent decline from its recent peak.

The index is down 17 per cent from its January 8, 2021 record of 13,643 points.

Valuing stocks using price/earnings (p/e) ratios is old-fashioned but it remains a tried and true method for many investors.

Even in today's soft market, Castle Point Funds co-founder Stephen Bennie says some stocks defy gravity.

"I'm always banging on about p/e because it's the one bit of jargon to get your head around when it comes to investing," Bennie says.

When investors buy shares in a company, they have purchased the right to a portion of that company's future earnings.

Past earnings are largely irrelevant in determining whether investors have a good or bad experience.

The most important driver of returns is future earnings, Bennie says.

"Clearly the future is highly uncertain, which is the reason why the sharemarket can be a highly volatile place."

The "cocktail of uncertainty" and human reactions to that uncertainty can cause severe market fluctuations. There is no hiding place from that volatility, and blue-chip stocks are just as prone to it as micro-caps.

"In our opinion, the best and only reliable defence against equity price volatility is to obtain a considerable amount of earnings for the price paid," Bennie says.

"You want earnings to be reasonably proportionate to what you paid."

He says Auckland International Airport, with its forward p/e of 40, is a highly priced stock.

"Obviously the bit to factor in is the change in earnings over time. That's the variable.

"But you have got to say that in some situations the variability in earnings is modest.

"And if you think about Auckland Airport, it's at the modest end - there are only so many planes that can come to New Zealand."

The airport company's market capitalisation stands at $11.2 billion and its pre-Covid earnings came to $275m.

"So even if you go back to its heyday, it's on 40 times its earnings - that's expensive."

Bennie says the world is changing and the old-fashioned methods of valuation will have their day again.

He maintains "value" investing has done better than "growth" investing.

Equity tourists

Rising interest rates have meant the "tourists" visiting the equity markets are packing their bags, says Salt Funds managing director Matt Goodson.

"Tourists in the equities market from the term deposit market are going back from whence they came. That's the reality."

Corporate bond yields are now in the mid to high 5 per cent range, some even in the sixes.

"That's significant competition if you are buying equities for their yield."

Rising bond yields have been a key reason for weaker share prices.

"Hopefully a more normal market come out this - one that is not propelled by the 'near-zero-interest-rates-forever' type mentality," says Goodson.

Comvita's share price has rallied. Photo / File

Comvita abuzz

Honey exporter Comvita has poured cold water on speculation that it may be a takeover target, yet the share price has ploughed on regardless.

"Comvita confirms that it has not been approached, and is not in discussions with any parties, regarding a potential takeover transaction," the company said in a statement to the NZX after the stock went into a brief trading halt.

"Comvita remains in compliance with its NZX continuous disclosure obligations and will continue to inform the market in accordance with them," said the mānuka honey manufacturer.

Earlier in the week, a report on financial news service Bloomberg said CR Capital Management was weighing a bid to take Comvita private. CR Capital is the investment arm of China Resources and has a 6.6 per cent holding in Comvita.

Greater China is Comvita's biggest market.

Passive aggressive?

The power of passive investing was on display this week when retirement village company Ryman Healthcare dropped out of the influential MSCI large cap index and moved to the MSCI mid cap index.

Passive funds automatically apportion their investments in line with indices, so index changes can have a big impact.

On the day the change took place - Tuesday - 39.3 million Ryman shares (8 per cent of its issued capital) traded.

Ryman dropped out of the index because its market capitalisation - under pressure from high debt levels and weakening house prices - has been in decline.

Agri index

A2 Milk has been included in a new S&P agriculture index across the Tasman.

ASX, in partnership with S&P Dow Jones Indices, this week launched the S&P/ASX Agribusiness Index.

The new broad-based index includes companies whose principal business activity is in the primary production of agricultural products or in the production of commodities used as inputs into primary production of agricultural products.

The index fills a gap in the family of indices representing the diverse sectors on the ASX.

The Australian exchange's Ken Chapman said the Agribusiness Index set a new benchmark for monitoring the performance of primary production companies and the primary sector as a whole.

"The profile of the agribusiness sector is hampered by the absence of an index benchmark akin to mining, energy, banking, property, healthcare or technology," Chapman said.

"The combination of accelerating climate risks, booming consumer demand, increasing complexity in geopolitical relations and supply chains, and exponential advances in technology is driving demand for capital in all stages in the value chain.

"By raising the profile of the sector, the AgBiz Index will increase investor understanding and interest, and be a critical ingredient in priming the market for the next phase of agricultural innovation."

The AgBiz Index will have 25 members with a combined market capitalisation of close to A$30 billion. It will include names such as Treasury Wine Estates, a2 Milk, Nufarm, Elders and Bega Cheese.