Ben Temkin
5 September 2008
column
Johannesburg — I MENTIONED yesterday that the historic price:earnings ratio of the constituents of the JSE life insurance index was 5,1 with an earnings yield of 10,3%. A possible guesstimate on its forward price:earnings ratio was 7,4 on earnings growth of 13,5% over the next year.
JSE figures for earnings are for consecutive half-years -- interim earnings per share are added to the previous interim. In the case of Liberty Group, the latest (June) half-year headline earnings were 332c. The previous half-year (June) earnings are the difference of the full year (December) earnings per share of 1117,3c and the previous half-year (June) earnings of 622,8c. This difference is 548,5c and, added to the 332c interim figure, the total historic one-year earnings per share were 880,5c. On Wednesday's closing price of R68,72, Liberty's historic price:earnings ratio was 7,8 and its earnings yield was 12,8%.
Liberty , and other life insurers, values itself on its embedded value -- the present value of its future profits added to the value of its net assets. Its embedded value at the end of June was R94,08. At a market price of about R69, the share is at a discount of almost 27% -- significantly under valued.
Embedded value is, however, a target that moves as quickly as the environment in which it operates.
The expectations of claims and discontinuations of life policies can't quite be cast in concrete but can be calculated with a high degree of probability.
Future investment returns and expenses are less predictable. In the 2007 financial year, the assumed investment return on government stock, equities, property and cash were 8,5%, 10,5%, 9,5% and 7,0% respectively. In the latest half-year, the assumptions had been changed respectively to 11%, 13%, 12% and 9,5%. The point of mentioning the changes is to highlight their speed and size of change.
When the actuaries have calculated the future profits (based only on business actually in force), this sum amount has to be discounted to a risk discount rate to arrive at a present value. The higher the discount rate is assumed, the lower, of course, the present value will be.
The risk discount rate assumed is 0,5 percentage points higher than the investment return expected on equity assets. At the end of last year, the discount rate was 11% and at the end of June it was 13,5%.
The actuaries also have to build in the possibility that the expenses to maintain the business will be affected by inflation. The inflation rate used at the end of last year was 5% and at the end of June it was 7,5%.
These changes in assumptions underline why I described embedded value as a shifting target.
But then, market ratings on investment fundamentals on all companies are an even more erratic shifting target than embedded value. As embedded value and share price ratings are prey to the bears, this is probably no consolation to Liberty's shareholders.
Be the first to Write a Comment!
Copyright © 2008 Business Day. All rights reserved. Distributed by AllAfrica Global Media (allAfrica.com). To contact the copyright holder directly for corrections — or for permission to republish or make other authorized use of this material, click here.
AllAfrica aggregates and indexes content from over 125 African news organizations, plus more than 200 other sources, who are responsible for their own reporting and views. Articles and commentaries that identify allAfrica.com as the publisher are produced or commissioned by AllAfrica.
