The market had some 'inexplicable' reactions to the latest ASX reporting season

Getty Images
  • There were few surprises in the latest ASX reporting season, although the market reaction to some results was “inexplicable”.
  • Nikko Asset Management’s Brad Potter said some companies which already looked expensive are now even more over-valued.
  • As a result, the divergence in price-to-earnings ratios across the ASX is now at the widest level since the 1999 tech bubble.

The latest ASX200 reporting season for the financial year ended June 2018 was solid if not spectacular.

More than three quarters (77%) of companies increased profits from the prior year, and overall earnings growth came in at around 8%, matching expectations.

So there were few surprises.

However, “the surprises came from the market reactions, which at times were just plain inexplicable,” said Brad Potter, head of Australian equities at Nikko Asset Management.

In particular, Potter highlighted investors’ ongoing love affair with stocks deemed to have high-growth potential — as opposed to those considered good value based on their performance metrics.

And following the latest reporting season, the valuations of growth stocks compared to value stocks in Australia has diverged even more drastically — a move Potter called “incredible”.

To demonstrate, he split ASX stocks into five groups based on their price-to-earnings (PE) ratio. (The PE is a common valuation technique which divides a company’s share price by its expected earnings over the next 12 months).

Here are the results:

Nikko Asset Management

What the chart shows is that stocks in the highest quintile saw their PE ratio rise by another 4.2 times.

In other words, companies which were already considered the most expensive — relative to their expected earnings — just got even more expensive.

“One of the poster children of this move is Domino’s Pizza, which released a result that was materially below guidance and market expectations,” Potter said.

Domino’s shares initially tanked by 13% after the company reported results on August 14, but then rallied to finish the month up 5% (including dividends).

In addition, the divergence in the PE ratios of the top and bottom quintiles is now at “levels not seen since the tech bubble of 1999/2000,” Potter said.

Nikko Asset Management

Following the latest reporting season, the top quartile of a high-PE stocks are now trading at a ratio of 30.7 times earnings, against the 20-year average of 19.7 times.

“It is apparent that some of the price moves preceding and during reporting season are not supported by fundamentals,” Potter added.

“Historically, such periods of irrationality have not been sustained and stock prices have ultimately reverted to valuations supported by fundamentals.”

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.