Could one of the best global investment opportunities be on the JSE?

Assessing the value in local mid-cap shares.
Distinct anomaly: mid caps have considerably underperformed large caps in recent years, which is meaningfully out of line with the longer-term picture. Image: Shutterstock

Across the world, stock markets are seeing an extreme and unusual divergence. There are certain regions and sectors that are highly in favour and therefore richly priced, while others are severely out of favour and looking extremely cheap.

“For instance, the difference in valuations between the S&P 500 and emerging markets is the highest on record,” says Greg Hopkins, chief investment officer at PSG Asset Management. “The difference between the most expensive and least expensive parts of the US market is the highest it’s been since the 1950s.

“And if you look at South Africa, there is a subset of South African shares where valuations are lower than they were in 2008 and 2009 (after the global financial crisis) and 2002 (after the dot-com crash).”

Predominantly, these stocks can be found in the mid- and small-cap sectors on the JSE. Traditionally, mid and small caps have outperformed the Top 40, but as the chart below shows, this has not been the case in recent years.

Source: FTSE Russell

The underperformance of small caps has been particularly dramatic, with this part of the market showing a negative return over every period up to three years. Mid-cap underperformance is less pronounced over the full five-year period, but since 2016 it has been substantial.

Extreme valuations

“What’s happened over the last three years is that mid caps have considerably underperformed large caps,” says Eugene Visagie, portfolio specialist at Morningstar Investment Management. “And that gap has widened quite considerably.”

As the graph below shows, this is meaningfully out of line with the longer-term picture. Over 10 and 20 years, mid caps have outperformed. This recent weakness is a distinct anomaly.

Source: Morningstar

A major reason for this is that sentiment towards this part of the market has grown extremely negative, as many mid-cap companies are highly exposed to the South African economy. Given the weak local environment, investors are extremely cautious about the prospects of these businesses.

However, there are some excellent and highly resilient companies in this universe that have been sold down heavily and are offering increasingly attractive valuations. They include the likes of fast-moving consumer goods group AVI, retailer Italtile, and financial services businesses RMI Holdings and Santam.

Mid-cap valuations
Counter P/E ratio Forward P/E Dividend yield
AVI 16.29 14.41 4.93%
Italtile 13.27 10.4 3.03%
RMI Holdings 12.36 9.05 3.57%
Santam 13.89 14.2 3.67%

Source: Profile Data

There are also other mid-cap companies that have experienced difficulties, and are now trading at more extreme levels. These include leisure group Tsogo Sun, forestry and paper company Sappi, asset manager Coronation, and chemicals group AECI.

Mid-cap valuations
Counter P/E ratio Forward P/E Dividend yield
Tsogo Sun 8.12 14.75%
Sappi 4.62 6.44 6.12%
Coronation Fund Managers 11.19 10.41 8.92%
AECI 10.06 8.11 5.45%

Source: Profile Data

A number of investors are now finding this combined opportunity set extremely exciting.

“Mid caps in South Africa are probably one of the most stand-out opportunities from a global perspective,” Hopkins argues.

Playing out

Even though the local environment is weak, some analysts argue that the valuations are so undemanding that the prospects for future returns off these levels are attractive. As Loftie Botha, portfolio manager at Momentum Investments, points out, if you take a view of the market as a whole the numbers are compelling.

“The median forward price-to-earnings (P/E) of all the stocks on the JSE with consensus forecasts is 10,” he notes. “However, the median of their historical P/Es is 14. That means a 40% upside.”

One might argue that analyst earnings forecasts are too optimistic, and the forward P/Es are therefore too generous. Yet even if one halves those assumptions, the upside is still 20%, excluding what investors might see from dividends. Currently, the median yield is around 4%.

“One shouldn’t bet the farm, but you don’t want to miss out when these things turn,” Botha says. “The market has been very disappointing for a very long time and even if sentiment only partially improves we could have a very attractive market and then mid and small caps should outperform.”

While some investors might argue that they would want to see an improvement in South Africa’s economic fundamentals before entering this part of the market, Hopkins believes one shouldn’t try to anticipate what might unlock this value.

“One of the dangers is to try to time this and look for catalysts,” he says.

“These catalysts come from different areas, and it’s difficult to stipulate where that will be and to wait for them,” Hopkins adds. “If there is apparent value and companies are not going backwards, we think that the best catalyst is time. Over long periods of time, when you have these anomalies, generally they play out.”



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NOPE !! Have you forgotten the looming JUNK STATUS?

Not to mention the current Eskom fiasco.
Perfect storm timing for CR’s investment / fundraising jaunt.

PEG matters more than PE.

Perhaps the market believes that for example Coronation will face decreasing fee income as people wisen up to the old bs business model and Coronation faces more competition. So their future earnings growth is reduced or negative, their future return on capital will be less, their DCF will be lower, etc etc. Also, recent and multiple big mistakes have laid waste to their past claims of being super wizards, removing any premium.

So why should a declining profit and profitability business with no moat and a loss of reputation have a forward PE of even 10?

Agreed. Money is flowing from actives to passives globally. Sygnia therefore likely to keep growing as their interim results show. Where do you get 20% growth in HEPs in SA?! And Sygnia’s AUM growing, Coro has been sinking. Peregrine and PSG similar problems (see results on Sens). On a 5 and 10 year view Sygnia is surely a massive asymmetric bet!

JTB, as much as I like Sygnia and their products, I would not bet on their share price giving you any real monetary returns over time. In Oct 2015 Syg stock was at about R13.70 and the Zar traded at R13 to the $. Now Syg is at R9 and the Zar is trading at R14.60. You do the math and work out how much yo would be down in real monetary terms over that period. I understand the past is not a good indication of the future, but in my opinion ZAR depreciation will eat into any real returns you may make with ZAR stocks.

I wouldn’t bet on Sygnia – its been a disaster in my portfolio – down 22% since purchase

Sometimes you can buy a flat and the rental income pays the bond. You don’t have to put a cent in when this happens (I have been lucky to be in this position previously).

Many small caps are in the range described above. Sygnia’s share price and free cash flows allow that. Do the maths! It is lean, has low debt levels, high ROE, substantially linked to offshore markets/rand hedging and has management that are honest and heavily co-invested. It has the tailwind of a global trend.

Here is another view

I looked at Sygnia in 2015 and concluded it was too expensive then. “Buy low, sell high”, not the other way round. Fear and greed. The more fear, the better for patient investors.

The past decade has been the Lost Decade for SA! TOnly stupid South Africans invested here, right? he rand has plunged, we have had a dysfunctional govt and gloom/fear has been pervasive. So, if you took your rands and bought locally or offshore 10 years ago, these are your % returns (offshore converted back into rands today). The results may surprise you.

US S&P 422%
Satrix Indi 231%
Satrix Fini 127%
Capitec 2167%
Naspers 680%
FTSE 100 ETF 104%
Satrix 40 112%
Eurostoxx ETF 82%
Transaction Capital 308%
Sanlam 278%
Santam 201%
RMB 349%
PSG 958%
Italtile 339%
Firstrand 280%
Spar 192%
AVi 352%
Afrimat 958%
AdaptIT 900%
Discovery 306%
Curro 326%

So much for relying on rand depreciation as a one way bet in investments!

JTB : sorry, I see no future in companies whose core premise is extracting a toll on other people’s money.

The concept that wealth/asset/fund managers take your R100 and charge you even 0.25% to place funds that will probably or virtually certainly then not even return the entire market return, is simply like prehistoric thinking. They will be entirely disrupted by a combination of DIY cheap brokerages and passive investing. It is like buying Sears in the face of Amazon or a NYC medallion for $600k in the face of ride hailing apps (as much as I believe Uber Lyft Taxify are pending disasters)

JTB The Zar was about R7.40 to the $ in 0ctober 2009.The SAP 500 was at 1080. The Zar is now R14.80 and the SAP 500 is at 3000. Where would you rather have been in the last decade, taking all the additional risks of investing in SA into consideration. I certainly would not be picking individual stocks. So I dont think your stats are fair, why not throw in Stienhof, EOH, Tongat and many others. Maybe compare Satrix 40 to SAP 500 then do the numbers over 10 years. Its easy to pick a few winning stocks.

Nice debate thanks for those insetting numbers…Have a great day.

1. US vs Euro VS UK vs Indi/Fini vs Satrix 40 is shown above!
(The wise investor would have taken all his money and put it in the US 10 years ago, when the US was in a terrible financial mess, and would have avoided Europe and UK and maybe SA Findi like the plague). That is history. But most people were very fearful of the US then, and of hyperinflation with the printing of money, coming on the back of a US market that had done nothing in 10 years…the so-called lost decade for US investors, as the press called it in the late 2000s.

2. Arguably, long-term, if you are to own some SA stocks in a globally diversified portfolio as a buy and hold, one should avoid resources. That has been my strategy for 13 years, topping it up with some individual stocks listed above. So, while I have listed returns for Satrix 40, I prefer Findi as a real comparison, where I have put much of my local money. The data shows that, by luck or design, this has been the correct approach. SA Findi has not done as well as US, but much better than UK or Euro!

3. The data argues against your reasoning that the only way to invest is via an assumption that rand weakening is the source of wealth. It ain’t. Had you taken your rands 10 years ago and flocked to the “safe havens” of UK or Europe, you would have been worse off than in SA Findi. Owning good businesses right around the world is the source of wealth, not currency games or bets on currency depreciation.

4. Long term data from one of the US’ most astute writers is worth reading, especially table 46 on p 81.
Bottom line? Watch out for markets where currencies are very strong, low dividend yields and where GDP growth has been strong (read US now!). The currency data in the table is pertinent to your argument about currencies!

5. How expensive is the US market now? Very! Future returns may be dismal!/?currency=USD&model=ER&scale=LINEAR&terms=REAL

Try and understand the CAPE! The US’ is twice its long-term average!

6. ETFs are here to stay for a good while. Most of the big SA savings is in balanced funds/RAs/pension/providend funds. That is sticky money looking for the cheapest home. Regulation is becoming ever-tighter…consolidation may occur.

7. Asset allocation requires careful thought, with diversification, care about not over-paying and asymmetric bets as central themes.

8. Individual share make up an ETF….nothing wrong with buying an ETF and adding some high quality individual shares, especially in a market as concentrated as in SA, where a few shares dominate the index…you can even things out a bit and reduce risk

JTB, GAA what a great read, very interesting, thanks for that.

Like trying to find the best chairs on the Titanic

Funny from someone who still lives there.

@Anything, do you ever make any sense in your comments. Nothing you say has any meaning. Serious chip on your shoulder…

Here’s a global investment opportunity…Platinum!
Recently I attended a Residents Association meeting in one of Londons top boroughs.
At the top of the agenda was the rise in theft of the easy to get to Catalytic Convertors on Hybrid cars for their platinum content.! That just about says it all….in my opinion.

Child like thinking. The reason why they are being stolen is the recycling. Rather invest in a platinum recycling company. This is the primary threat to Pt producers.

A little knowledge is more dangerous than none at all.

I would like to ask these SA stock punters what they think the ZAR will do over a long period of time, how EKSDOM will affect these stocks, and do they factor in these major risks when punting SA stocks? As international investors definitely do, along with policy uncertainty, Land expo without compo, ease of doing business in SA, corruption and crime and many more factors when considering if an SA stock is priced to buy. My opinion is, I wouldn’t even touch an SA stock with someone else’s money.

You keep on punting, PSG (and Old Mutual/Allan Gray/Coronation) and we will keep on dumping. Someone has to buy the junk….

Yeah, cos your ‘dumping’ of a merger holding is totally significant right.

Thanks Patrick, interesting article.

Unfortunately my investment platform does not provide access to a small cap fund.

For South Africans wishing to spread the risk there are emerging market funds. It could be interesting to analyse opportunities in this space.

Look for large caps to get expensive before looking at mid & small caps. Quite a few large caps offer value at current levels. Follow the money.

Bet the farm? Ja but whose farm?

The catalyst SA is looking for….is ‘time’. What?!

The concept of TIME is present in ANY market. So this ubiquitous factor of time needs to be discarded. Instead, one needs to look for specific economic, or political strategic events that will shape the future.

VENEZUELA also has “time”. It must be the best ever global equity market to invest in?
(How about investing in the Damascus Securities Exchange in SYRIA? Syria also has time.)

Yaa. Hey? Not sure about the “Investment” part. That would mean I have to hang on to something for a minimum of 3 years not to be regarded as a trader in SARS terms.

Even in African time 3 years is to long and you will never be compensated for the risk associated with holding a SA Inc counter for that long. Remember your “Investment” has to beat risk free by a good margin.

Trading opportunities plenty as you can also go short. Forget about the political and other noise associated with this lot and chuck fundamentals out the window. Audits have been done by the Deloitte’s and the likes of the world anyway and mean NOTING.

Just some technicals and a candlestick or two. No Eskom required. Haha.

If you really want to be in the JSE just buy the Satrix ETF 40.

I don’t know what is going to happen in the future….. it all feels quite bleak….. reading the comments on this article it seems few are willing to consider SA Inc at any price….. the allure of offshore is high….. tons of reasons for Rand depreciation, great investment opportunities offshore even if a “little” expensive…but the traffic seems decidedly out of SA….

Whenever I look at at historic graphs, be it of major stock indices or FX rates it always amazes me how we reach extremes….what were people thinking???? Why so optimistic….. why so pessimistic…. I’m a bit tired of everyone being a behavioural finance expert and seemingly identifying when we are making emotional mistakes which affect our investment returns….or not as the case may be….

But if someone was to give me R100,000 today and say I must invest and hold it for 10 years regardless of what happens….. do you want to buy the S&P 500 or JSE All Share (bring in the midcaps too)….? I think based on the sentiment here alone I would have to go with the SA market, currency risk included….

I think perhaps this run since 2008/2009 without any real market pullbacks has everyone a little complacent about the potential downside in developed market equities from current levels….

No. Due to Junk, Covid-19, Brexit and world in recession

End of comments.




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