AB Inbev has recently announced that they intend to complete one of the biggest mergers in history, namely that of them and SAB Miller. It is astounding to see that a well-run South African company is being valued at about R1.4 trillion Rand. The SAB share price rose by 30% (just slightly lower than the suggested take over price) since AB Inbev intentions became clear, because most investors assume that AB Inbev will be able to pass all the regulatory hurdles and thus complete the deal. SAB Miller certainly was no cheap buy, since their share price always traded at a slight premium to other brewers partly because of their exposure to the growth markets, and partly because they were always seen as a take-over target. If the shares were expensive before the take-over rumors started, they are certainly very expensive now. So you might ask what has all of this to do with buying Index trackers?
The problem with the South African stock exchange is that it is dominated by a few really big companies. If you add up the market capitalization (ie the value of all the companies), you get to a figure just slightly higher than R10 trillion. If you then divide the market cap into 3, the top third of companies is made up of only 3 companies, the next third of 14 companies and the bottom third of 153 companies. Thus our market is very concentrated, and share price moves of a few big companies have a far greater impact on the index than the performance of many smaller companies. So which are the top 3 companies? The biggest weight is British American Tabaco (BAT), closely followed by SAB and then Naspers. The performance of these three shares have got as great of an impact as the performance of 153 smaller companies.
The problem at the moment is that the top 3 companies are all trading at a P/E more than one standard deviation above their long term mean. Even though the historical P/E is not a precise determination of value, it is a fairly good indicator. SAB’s P/E is above 34 now, and Naspers above 100. This is astronomical stuff, and you would have to expect massive earnings growth to justify such high P/E’s. As a fund manager, you would have to have really strong conviction to buy such highly priced shares. Surely there are better opportunities that offer better risk-reward returns. However, an index tracker fund does not do such decisions. 1/3 of your money would be spent on buying such expensive shares. I am not sure if that is such a good idea. This environment definitely favors good fund managers with an established track record.