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Equities remain tops for the longer-term

31 July 2014 Adriaan Pask, PSG Wealth
Adriaan Pask, PSG Wealth CIO.

Adriaan Pask, PSG Wealth CIO.

Equities remain a better investment for the medium- to longer-term. More conservative investments are however important for protecting short-term cash flow in a portfolio, but is not geared for generating long-term earnings.

PSG Wealth CIO, Adriaan Pask, is of the opinion that investors that revert to more conservative investments when market volatility increases, are paying a high price that will have a negative impact on long-term investment objectives.

To illustrate this, a fairly common measurement like the price-earnings (P/E) ratio can be used. It is usually used to determine the relative value of equities, but its usefulness can be extended to other investments.

A high P/E implies that investors are paying a relative high price for the earnings being generated by the listed entity. A low P/E implies that investors are paying a relatively low price.

“The ratio also tells us roughly when investors may get their money back. If the P/E ratio is for example 20, it means that the current price per share is 20 times the current earnings per share. If the price of the share is R20 per share, the earnings would be R1 per share.

“This implies that the investor would need 20 years’ earnings (assuming earnings remain unchanged) to recover the money they spent on initially buying the equity. This provides us with a handy estimate of whether an investment offers value for money,” says Pask.

The P/E ratio can also be applied to cash, bonds and property, which also have a price and expected earnings.

Currently the effective yield on a cash investment is roughly 5.6%. This means that for every R100 invested, earnings of R5.60 are being generated. The implied P/E ratio for cash would therefore be 17.9 (R100/R5.60).

When applying the same methodology to offshore and South African cash, bonds, and property, the results can be summarised in the following chart. The P/E ratios are indicated in black. To provide context, the gold bars represent the historical average P/E ratios.

Global and domestic asset classes: number of years to recover an initial investment

Interestingly, the chart shows that global cash (as measured by the 3-month US$ interbank rate) has a P/E of 424, derived from the low current yield of 0.24% per year. At the current earnings yield, investors would implicitly wait 424 years to recover their initial investment.

Global equities have a P/E of 17.9, and South African equities a P/E of 17.8. “At first glance, this seems like a much better investment than global cash,” Pask concludes.

 

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