Finding value in a depressed earnings’ environment

Looking in the rearview mirror and taking South Africa’s current political and economic landscape into consideration, it is easy to be despondent about the JSE’s return prospects. But it’s important to get the full picture, and not be swayed by headlines over facts.

This is according to Rory Kutisker-Jacobson, fund manager of the Allan Gray Equity Fund, who says that shares listed on the JSE are cheaper today than they were a decade ago, and that the Fund is still finding several attractive opportunities, such as Mondi and Sappi.

“Even though there have been very few places to hide, with 26 out of the top 40 stocks down in nominal terms over the first quarter of 2024, we are still finding opportunities. However, the opposite is true of many American listed companies,” says Kutisker-Jacobson.

JSE: A disappointing decade

In 2023, the FTSE/JSE All Share Index (ALSI) returned 9.3% in rands, while the FTSE/JSE Capped SWIX All Share Index (Capped SWIX) returned 7.9%. Although positive, one could have achieved a similar return from cash while taking on considerably less risk. To make matters worse, in the first three months of this year, markets have given roughly a quarter of this back, with the ALSI down 2.2% and the Capped SWIX down 2.3%.

Kutisker-Jacobson explains that if you were a global investor over the last 13 plus years, for every R100 invested in the ALSI at the end of December 2010, you would have approximately R360 today, including all dividends reinvested. In US dollars, a US$100 investment would only be worth about US$126 at the end of March 2024, given that the rand has weakened from R6.62/US$ to R18.88/US$ over this time. Excluding dividends, in nominal terms, the value of that investment would be down in US dollars. In contrast, a US$100 investment in the USA’s major index, the S&P 500, in December 2010 would be worth roughly US$539 at the end of March 2024 – more than four times the return experienced on the ALSI.

Three reality checks

“However, it must be remembered that the JSE has not been the only bad stock market to invest in over the past decade. Most emerging markets have fared poorly, and the JSE has performed largely in line with its peers,” he says.

By way of example, US$100 invested in the MSCI Emerging Markets Index would be worth approximately US$131 at the end of March 2024.

“Indeed, the past 13-plus years have been more a story of exceptional relative returns from US companies than anything else. The S&P 500’s returns have been roughly threefold greater than those of the UK’s FTSE All Share Index over this same period.”

He says that the second fact to remember is that starting prices matter.

At the end of December 2010, the ALSI was trading on 17.2 times earnings, while the S&P 500 traded on 14.7 times earnings. At the end of March 2024, the ALSI had derated to 13.1 times earnings, while the S&P 500 had rerated to 21.6 times earnings. Underlying earnings growth has been superior in the US, but this change in sentiment has had a big impact on returns over time. The ALSI has gone from trading at a premium to trading at a material discount to the S&P 500.

“Thirdly, there is an increasingly large number of multinational companies that happen to be listed on the JSE but derive more than 80% of their revenue and income from markets outside South Africa. They may be listed in South Africa, but their fortunes are not tied to the domestic economy. This is the case for British American Tobacco, Naspers and Prosus, AB InBev, Glencore and Mondi, all of which are top 10 positions in the Equity Fund.

“While we cannot predict what returns to expect over the next 13-plus years, we can focus on the factors within our control: buying out-of-favour companies at below fair value,” he concludes.