If, after critical analysis of a company, you're satisfied that its forward single-digit price:earnings ratio is sustainable, the indicator has to be right.
If your analysis tells you that earnings should improve, then the forward price:earnings ratio will be lower than the historic ratio. This implies that the shares are undervalued.
Yesterday, I made a forward view on Pick n Pay's return on assets for its current year to next February. My guesstimate was that the company could sustain a return on assets of 16,3%.
My suppositions were that its asset turn (the ratio of turnover to assets) would improve while the other driver of the return on assets, the operating margin, could well stick at the latest half-year figure of 2,9%.
If Pick n Pay achieves my guesstimated return on assets, the company should comfortably improve its headline earnings per share of 15% or more over the year. On this conjecture, its forward headline earnings per share on continuing operations are 237c.
At Wednesday's market close, Pick n Pay's share price was R27,50. On this share price, the guesstimated forward price:earnings ratio for financial 2009 is 11,6. Although this is no single digit, I bet you that Mobius's fund managers have not dismissed Pick n Pay as a prospective investment.
They would, in particular, have taken into account the generous dividends the company pays: about 70% of earnings. My guesstimated forward earnings yield is 8,6%, and the projected dividend yield is 6%.
On the investment made by the Private Investor portfolio, the expected earnings and dividend yields over the next 12 months are 7% and 4,9%.
The portfolio's forward price:earnings ratio for Pick n Pay is 14,2. Before the bears took over the market, these market ratings would have been regarded as good value.
I've looked at Shoprite's and Spar's shares to compare how the market rates them. In both cases I have guesstimated bottom-line earnings per share annual growth of 20%. I have used a higher rate of growth in earnings because both companies performed better than Pick n Pay in their latest reporting periods.
I guesstimate Shoprite's forward price:earnings ratio is 12,8, the forward earnings yield is 7,8% and the dividend yield is about 4%. Spar's corresponding figures were: 11,7, 8,5% and 5%.
These ratings confirm that the market continues to believe that people have to eat even if, as expected, food prices keep rising.
The market also apparently expects earnings growth from the companies that sell food should be sound and that Pick n Pay's earnings growth could lag that of its main competitors.
The market, however, is not paying a premium for Pick n Pay's generous dividend payouts.
Bears are savage. Consider for a moment Old Mutual. At a share price of R9,79 at Wednesday's market close, the bears have eaten its historic price:earnings ratio to below 3. If its bottom-line earnings are maintained — the market obviously expects a fall — its earnings yield is more than 35% and its dividend yield is nearly 12%.
Source: Business Day
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