How do I explain short-term share price volatility – by Guillaume Oberholzer
During the third quarter, the JSE dropped 5,7%, property shares were down 3,76% and investors’ courage and patience slipped into their shoes. This was definitely a quarter to forget. For the year to September 30, however, the JSE is 7,53% positive and property shares 1,34% positive.
For the past 12 months, the JSE is only 1,53% positive and property shares negative with 2,51%.
The above indicates a volatile and uncertain investment environment. The challenge is not limited to South Africa, but is currently a challenge worldwide. Fortunately, every challenge creates opportunities… I would like to refer again to my December 2018 letter:
“The time to buy is when there’s blood in the streets.”
Baron Rothschild, an 18th-century noble, bought shares during the panic on world markets following the Waterloo battle against Napoleon and made a fortune. He said the above, but also adhered to it.
What do these opportunities look like?
For the last couple of years, the profits of many JSE companies have risen with low, single-digit percentage points or stayed the same due to the difficult economic conditions and reluctance to expand in the challenging political climate.
Despite equal or rising profits, many share prices are significantly lower. The maths behind the decline is as follows:
Investors buy profits. Earnings per share play a role in the price per share an investor is willing to pay.
The formula looks like this: Price per share divided by profit per share = price earnings ratio (PE). The PE that an investor is willing to pay for profit determines the price of the share because the sum is made on actual or estimated profit. The variable in the ratio is the price per share.
Example: Company A’s proposed profit for the financial year is R1 per share. Investor B is willing to pay a PE of 15 and therefore buys a share at R15. The reason for the PE of 15 is that company A has a competitive advantage in terms of technology and production costs of their product over their competition. Investor B’s return on purchases is 1/15 = 6,67%. If profits grow strongly and increase to R2 per share, the return is 13,33%. If the PE is still considered 15 by buyers, the share price will double to R30.
However, economic conditions are deteriorating rapidly and there are fears about possible levies on exports of Company A’s product. This can negatively affect their profit growth.
Investor B wants to sell its share, but the buyers are only willing to buy at a PE of 10 because of the uncertainty and possible risk. Should investor B accept the offer, the price would be R10 and a loss of 33,33% will result. This is despite the profit that will still be R1 in the current financial year.
What to remember in times like these…
Investments are about the quality of the company(s) you invest in, their fixed cost structure for when transactions are scarce, and the amount of debt they must service.
Stock prices can drop quickly, but they can rise again just as quickly (the above PE calculation also works as prospects improve).
Q4Y19 What to expect?
Volatility, volatility and uncertainty. Britain and America will make it the dominant theme for the rest of the year.
America (excluding their president) is reluctant to cut interest rates and that will mean less stimulation for the world economy.
The last quarter of the year is globally seen as a spending quarter. Year-end functions and parties, Christmas and holidays. December 2018’s spending was, however, disappointing and we can expect the same for December 2019. This could negatively impact many retail stocks.
On a positive note: South Africa is now getting an electronic visa system that could boost tourism in 2020. Tourism is an excellent opportunity for SA to get new money into the country and create jobs.
This, together with much-needed rainfall across South Africa, for agriculture, human use and production, as well as political stability, can make 2020 a better economic year than 2019.
Please contact one of our expert advisors for further information.
The above-mentioned is for information purposes only and is in no way advice. Boshoff Visser Konsult (Pty) Ltd. encourages readers to get in touch with an expert financial advisor before making any decisions.