aussie stockmarket to continue rising

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    On Deutsche’s calculations, the market’s one-year forecast P/E ratio is about 14.9x, which compares favourably to the almost 20x earnings the market was trading on at the beginning of the decade

    If a picture can tell a thousand words, imagine how many stories one can derive from twenty pages
    of graphs and tables.

    AIR spent some time and effort analysing a graphic market update by Deutsche Bank up until August
    31. The document suggests on several measures, such as the market P/E ratio and earnings yield,
    that Australian equities still offer reasonable value.

    On the broker’s calculations, the market’s one-year forecast P/E ratio is about 14.9x, which compares
    favourably to the almost 20x earnings the market was trading on at the beginning of the decade,
    though it is above the Australian market’s long-term average.

    Additionally, the earnings yield on stocks is almost 2% higher than the yield offered by 10-year
    bonds, even before franking is taken into consideration.
    Helping here is the increase in dividends that has accompanied higher profi ts, with the analysts
    forecasting the one-year dividend yield to again reach almost 5% for leading industrial stocks.

    This differential is enough to suggest equities are currently cheap in relation to domestic bond yields,
    a continuation of the conditions in evidence for the last three years or so. (see chart).

    But this fall in the P/E ratio also represents the strong earnings growth companies have enjoyed in
    recent years, though this may not continue at the same rate.

    As the graphs point out, growth rates are turning down and EPS growth is likely to weaken in 2006
    to about 7.1% and in FY07 to 7% for leading industrials, in comparison to this time last year when
    EPS growth was above 8%.

    Looking at the industrials ex-banks the outlook is
    even less attractive, as forecast EPS growth is
    around 6% compared to more than 10% a year

    Helping the overall market look attractive is the
    resources sector, where Deutsche Bank notes
    EPS growth forecasts for 2006 are for a result of
    about 20%, compared to less than 15% this time
    last year.

    So on face value the market outlook appears good,
    but as with many things looks can be deceiving.
    A sector-by-sector approach to assessing the
    10-year bond yield/earnings yield market’s outlook makes it clear performance is being driven by a few sectors generating strong results, while poor results in other sectors are holding back the average.

    For investors this becomes crucial, as being overweight underperformance or underweight outperformance can significantly drive down returns.

    Using Deutsche Bank’s All Industrials EPS growth rate of 7.1% in 2006 as a benchmark, it is possible to identify those sectors expected to do better or worse than the broader market.

    Taking out the Infrastructure & Utilities sector where earnings are impacted by accounting treatment, underperformance is most likely to come from the Insurance, Paper & Packaging and Telecommunications sectors.

    All three are forecast to provide negative EPS growth in 2006, though for Paper & Packing a substantial recovery is foreseen in 2007.

    At the other end of the scale, Health Care & Biotechnology, Retail (maybe somewhat surprisingly
    given the slowdown in consumer spending), Building Materials and Media are expected to offer the
    strongest growth in EPS, all generating increases greater than 15%.

    Resources not surprisingly are expected to be strong contributors also, the broker’s earnings forecasts indicating the major resources stocks will generate a weighted average increase in EPS pre-goodwill and amortisation of 23.4%, this after growth of 73% in 2005.

    By 2007 the resources sector may be seeing some slowdown, with the broker estimating EPS growth in that year of 10.6%.

    Looking at other sectors to get an insight into where longer-term performance may come from, on Deutsche’s forecasts the Media and Healthcare & Biotechnology sectors will continue to generate strong EPS growth into 2007, while Chemicals and Food & Household Goods should both experience an increase in
    EPS growth that year.

    In contrast, the 2007 outlook for Diversified Industrials is not so favourable, as its forecast EPS growth of 12.6% in 2006 is expected to reverse to a decline of 8.1%.
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