Australian investors often lament the performance of our market. They look at other markets and wonder why ours can’t be the same.
They look at the US and see a market — the biggest in the world — that has trebled in nine years.
Even Japan, the forgotten economic powerhouse, has done the same thing. Considered a basket-case for decades, its market has also tripled over the same time.
Back in 2009, Japan’s Nikkei index was battling to stay above 7,000 points. Less than a month ago, however, it breached 24,000 points.
Perhaps even more impressive is just how rapidly the Nikkei has risen. It has achieved most of this gain in the last five years.
All the while, our Aussie market has struggled. The ASX 200 is still around 900 points below its 2007 high.
Some put the performance of Japan and the US purely down to money printing. That all the money central banks have printed has found its way into the markets.
And in some parts, that is true. But where the real difference lies is in the companies that lead their respective markets.
The big players in the market
We all know that financial stocks dominate the Australian market (around 40%). That the Big Four banks account for about 30% of the index. Remember, an index simply reflects the stocks that are in it.
Last year, the biggest stock in our market, Commonwealth Bank of Australia [ASX:CBA], generated a profit of almost $10 billion. It was a result that drew gasps at the time for its sheer size.
However, while that profit was 8% higher than the previous year, revenue hardly budged an inch. All up, revenue grew by just 1% for the year.
Compare that to behemoth Apple Inc. [NASDAQ:AAPL] in the table below.
Apple net sales — 2004–2017
[Click to enlarge]
From 2004 through to 2015, Apple grew its sales exponentially. Sales in 2015 were almost 17-times higher than a decade before.
After struggling for growth over the last couple of years (red circle in the table), Apple announced earlier this month that it was back on track.
For the December quarter, sales grew 13% to US$ 88.3 billion. Earnings per share grew 16%. All up, as the company noted, it was the best quarter in Apple’s history.
It is growth like this, along with a corresponding jump in profits, that has propelled Apple’s stock price higher. Its share price has grown 20-fold over the same period, as you can see in the chart below. Over the same period, CBA’s has not much more than doubled.
Apple monthly share price
[Click to enlarge]
Even after such a massive and sustained rally, Apple is trading on around 15-times its 2018 forecast earnings (P/E). The low-growth CBA, by comparison, it trading around 13-times earnings.
That’s why stocks like Apple, with its US$871 billion market cap, have continued to propel US indices higher. And bank stocks with their huge weighting (and anemic growth) have put a handbrake on the Aussie market.
Even when Apple’s earnings went sideways in 2016–17, Apple’s share price almost doubled over the same time. The market was still pricing it for growth.
However, there’s a problem for markets such as those in the US: What happens should this strong growth stop?
While Apple’s P/E is not excessive compared to the market, there are other companies where it is stratospheric.
Take Amazon.com, Inc. [NASDAQ:AMZN]. With a market cap of $710 billion, Amazon is not much smaller than Apple. Yet it trades on around 320-times its current earnings.
Then there is Tesla Inc. NASDAQ:TSLA]. It has achieved a market cap of $56 billion without ever having made any money.
It’s when sentiment towards these stocks changes — and the economy as well — that investors no longer price them for growth.
Instead, they will have to prove to the market that they are worth their lofty valuations. That they really can make a profit and generate a sufficient return on capital. This is when the market finds out the truth about a stock.
But it’s the cash a company generates that ultimately determines its value.
If they can’t justify their value, there is another asset class which beckons. As interest rates ratchet higher in the US, investors will have another choice…they can instead park their money into bonds.
The very thing that implies a growing and healthy economy — increasing rates — could pull money out of the market, bringing this bull market to an end.
All the best,
Editor, Total Income