Aussie large-cap valuations? "They're nuts"

It’s been a pretty good year for the top end of the Australian market.

In fact, over the past twelve months, the average return (before dividends) of the ASX’s five largest companies was over 16.5% -- at a time when the ASX 200 has only increased by around 8.0%.

It’s a stunning situation. The top five companies, which make up around 20% of the ASX 200, has significantly outperformed the market. However, according to Simon Mawhinney, managing Director and Chief Investment Officer of Allan Gray, such a performance could be a reason for concern.

At the recent Livewire Live event, as part of a panel titled High conviction: What we’re backing for the long term, Mawhinney didn’t mince his words when it came to the valuations of Australian large caps:

“I guess it’s nuts that they’re priced the way they are for the growth they’re delivering.”

In fact, as Mawhinney pointed out, many have seen their individual share prices far exceed the earnings growth, or in the case of many, the lack of earnings growth, delivered by the individual companies.

Mawhinney specifically called out Commonwealth Bank (ASX: CBA), NAB (ASX: NAB), Westpac (ASX: WBC), Wesfarmers (ASX: WES) and Goodman Group (ASX: GMG).

Despite earnings collectively going backwards over the last five years, Commonwealth Bank, Wesfarmers and Goodman are currently trading at or over 27x next year’s earnings. This was similar to American tech darling, Nvidia (NASDAQ: NVDA), which its critics frequently accuse of being expensive.

The one difference, according to Mawhinney, while those three companies are growing earnings at around 6% per annum, Nvidia has been growing its earnings at 27%.

He had one key takeaway:

“At the end of the day, the maths does hold. You can’t have trees grow to the heavens and sooner or later fundamentals must come home to roost”.

This was a point he again returned to reminding the crowd that a company is simply worth the present value of all future cash flows.

One stock he did like was industrial safety company, Ansell (ASX: ANN). A core holding of his fund’s portfolio, he believes Ansell is a boring business that no one cares for. But, with strong management, earnings growth and a reasonable valuation, it offers a great combination of capital protection and upside.