LONDON, 25 August 2003 — After a row of upbeat macroeconomic releases, it is time to look how equity analysts have reacted to the brightening macroeconomic picture. Normally, an improvement of the leading economic indicators goes hand in hand with higher earnings estimates. The August IBES earnings estimates released last Monday confirm this correlation. Forward earnings per share (EPS) for the MSCI World index increased by 1.1% in August. EPS estimates have been in an up-trend since the end of 2001 and it seems that the EPS estimates have gained momentum after a sideways movement between summer 2002 and January 2003.
From a valuation point of view, the recent increase in equity prices is basically justified. Though it is true, that prices increased faster than the EPS estimates (i.e. the PER increased), equities are not expensive. The PER at 16.9x is slightly below the 15-year historical average at 17.7x.
The Telecommunications Services sector experienced the largest upward revisions. EPS estimates were revised upward by 8.5%. The earnings momentum for the Telecommunications Services sector has been much stronger than for the MSCI World since fall of 2002. With the positive earnings momentum, the price to earnings ratio (PER) came back to 31.3x. The PER is now within the fair value area, which we define as the mean plus minus one standard deviation. We still have a neutral stance on the Telecommunications Services sector, as valuation is not cheap (yet). Our preferred stocks in this sector are Vodafone Group and SBC Communications. SBC Communications trades at a low 14.8x forward EPS and Vodafone at a 15.8x forward EPS before goodwill.
EPS estimates for the Information Technology sector were revised upward by 2.2%. IT earnings estimates were revised upward continuously since fall 2002. High-tech production has grown much faster than the production of “low-tech” industries. The capacity utilization rate of the computer industry has increased strongly and is above the 15-year average. High capacity utilization should help to boost computer industry’s profits in the future.
On the other hand, the telecommunications equipment industry still struggles with low production growth and low and falling capacity utilization rates. From our six favorites IT stocks only Nokia falls into the MSCI industry “Communications Equipment”. But Nokia is basically a mobile phone company (more than 75% of its turnover) and not a network provider company. It trades at a low forward PER of 17x compared to a PER of 32x for the Communication Equipment industry. The Health Care sector EPS estimates were also revised upward (by 2%) in August. They are characterized by an extremely steady growth, which is basically independent of the business cycle.