An interesting commentary on SA equities in 2013 from Patrick Barker from Cannon Asset Management.

Rather than boring us with a long note summarizing last year, he thought that the following few charts would tell us all we need to know about South African equities in 2013, starting with trying to explain to your children why crazy Mr. Market pushed prices up 18% when earning fell 6%.

Chart 1: Explaining JSE prices and earnings in 2013 to your children


How this occurred, if not why, is shown in Chart 2.  Price Earnings (PE) ratios for large cap shares (the Top 40 that makes up 85% of the JSE) rose nearly 24%, despite their earnings falling 8% in 2013, implying that crazy Mr. Market has made them much more expensive relative to their declining earnings base.


Chart 2: Large and small cap earnings growth versus their change in PE for 2013


Source: Keith McLachlan,

But amazingly, small cap shares grew their earnings by 20% and crazy Mr. Market made them cheaper by pushing their PEs down by 2%.  We have spoken in the past about small caps being the elephant in the room that investors seem to be missing.

And finally an update on a chart we have shown before.  A staggering 11% of last year’s 18% market rise was from Naspers, Richemont and SAB Miller.  If you owned all other 157 companies that make up the index, your return was just 7%!


Chart 3: The 20 largest individual stock contributions to the JSE’s return in 2013



Some more interesting stats about last year:

  • 60% of the shares on the JSE underperformed the All Share Index.
  • The Cyclically Adjusted Price Earnings (CAPE) ratio of these underperforming shares fell marginally through the year from 15.9x to 15.3x;
  • Their current average price to book is 2.5x; and
  • Their average Return on Equity (profits over balance sheet capital) is 13%.
  • 40% of the shares on the JSE outperformed the index.
  • The average CAPE on these outperforming shares rose from an already expensive 19x to a very expensive 25x;
  • Their current average price to book is 3.3x; and
  •  Their average Return on Equity is 16%.

So while shares that outperformed the market last year do enjoy slightly higher ROEs (16% versus 13%), and should therefore have some valuation premium, do they warrant a CAPE of 25x versus 15x?  The answer is most likely not.


And what conclusions can be drawn from all of this?

  • While the JSE in aggregate did well last year, this was driven by, in particular, a narrow band of expensive (but typically good quality) large cap industrials that got more expensive.  These areas of the market represent investment risk, and investors should be cautious here.
  • And while the sexy stocks grabbed all the headlines, the index rise masked many amazing opportunities that have been created elsewhere in the market, including smaller cap shares.
  • Don’t go and sell all South African equities.  Just be very careful which of them you own.