An update on Equity Risk Premium for STI

As of 30 Jun 2016, Straits Times Index closed at 2,840.93. The implied equity risk premium (ERP) that I calculate through a Discounted Cash Flow model is 4.42%. Compared to 18 Jan 2016 when STI is at 2,580 with the implied ERP at 5.56%, STI has recovered 10% and it has moved from a highly undervalued market to a modestly undervalued one.  To support this slight undervalued market notion, the 12-month forward PE ratio is at 11.98x, still hovering below STI’s 12-month forward PE -1SD at 12.2x.

The 12-month forward PE is lower due to Earnings per share (EPS) growth for 2016 has been revised down from 5%, Jan 2016, to 2% as of Jun 2016. Risk free rate has also dropped to about 2% but dividend yield for STI is still a decent 3.9%. Bargain stocks will be harder to find in this market. With market rallying in the first half of July, ERP has further fallen to 4.29% with the index at 2,925 on 15 Jul 2016. This means that investors are expecting a total return of 6.29% by investing in the market, fallen from 8.02% in Jan 2016.

As seen in my first post, Prof Damodaran’s compilation of implied ERP on the US equity market (a good proxy for Singapore’s historical ERP), the 75^th percentile of US Equity Market implied ERP from 1960-2015 is 4.93%. This means that Singapore’s current implied ERP of 4.29% signify a more cautious optimism for STI in the near to medium term.

An interesting observation is also that the payout ratio of companies has fallen from 60% to 52.8% and on a rolling 12-month basis, share buybacks conducted by STI constituents have been lower by 8%. In the near term, shareholders’ return that focuses on dividends will definitely be impacted given slower growth in earnings and thus lower payout ratio by companies. In addition, this is enforced by a relatively lower yield environment where investors hunt for dividend yield stocks - prices go up and yield goes lower.