08.04.2010The year has had a solid start for Finnish equity investors. The Helsinki Stock Exchange has already soared 14% after the turn of the year including dividends, while the global equity market has only risen by about 4% over the same period.
There are many reasons underlying the outperformance of the Finnish equity market relative to the rest of the world, including the cyclical sectoral breakdown, solid price performance of individual large cap companies and more-generous-than-expected dividends on the Finnish exchange. As the Finnish equity market has gained almost 100% over the past 12 months, the valuation level has become increasingly challenging. Although we continue to have a positive view of the Finnish equity market, we see room for a correction clearing the atmosphere towards the summer.
Support from dividend yields - for the time being
Positive sentiment on the Helsinki Stock Exchange in the early part of the year has been supported by dividend proposals clearly exceeding forecasts. Although already at the end of last year, we predicted high payouts in relation to companies’ earnings, the dividend proposals have clearly exceeded our expectations. The payout ratio, ie the proportion of profits paid to shareholders as dividend, surged last year to as high as 67%, while a year earlier it only amounted to some 44%. The aggregate dividend sum rose to almost EUR 7.5 billion, which is about 10% more than a year ago.
There continues to be uncertainty about companies’ outlook for the current year, but the content of guidance has turned more optimistic, and in our view the dividend increases point to stronger confidence. On the back of the improved cyclical setting, the more stable earnings outlook, reduced refinancing risks, strong cash flows and conservative investment plans also explain the generous profit distribution.
Another interesting aspect in this spring’s “dividend party” is the ongoing debate on dividend taxes, which we believe has had an impact on the payout proposals. Discussions about a potential tightening in the dividend taxes for listed companies have intensified, and this may also spark a round of extraordinary dividends in the autumn. This is what happened six years ago before the dividend tax reform of 2005.
At the moment, fixed income yields do not offer a competitive alternative to equities. On the date of this article, the average dividend yield on the Helsinki Stock Exchange is about 4%. However, as many Finnish equities have risen by multiple times their dividends during the rally in the early part of the year, now at the beginning of the new quarter and with the passing of the AGM season, we see increased risk of repatriation of profits.
Optimistic earnings expectations
The equity markets are displaying solid trust in an improvement in the operating environment and earning power of Finnish companies. According to the consensus forecast (Datastream), the earnings of companies on the Helsinki Stock Exchange are expected to increase by over 40% this year. On the other hand, the high level of the earnings growth forecast is affected to a large extent by the comparative period’s low starting level since last year’s results were suppressed by large extraordinary items, such as write-downs and restructuring expenses. We expect operating profit growth to remain more moderate than the forecast above, at about 20%. In light of the forecasts, the average P/E valuation of the stock exchange amounts to over 17, which is clearly above the long-term average.
After streamlining measures Finnish companies’ earning power is now solid. Consequently, thanks to operative leverage, a pick-up in demand will show quickly on the bottom line. In the Q1 reporting season looming just ahead, our attention will focus particularly on companies’ growth guidance. Then again, the road to earnings surprises through cost-cutting has been exhausted by many companies, and therefore we do not consider the expected earnings improvement likely in the absence of a clear recovery in demand. In addition, the markets’ earnings expectations have risen steadily since last summer, leaving less room for positive surprises.
Period of easy profits has passed
With respect to the whole year, we continue to have a positive view of the Helsinki Stock Exchange, but expect higher price volatility and clearly more moderate price gains than last year. In the search for future profits, successful stock picking will play an increasingly important role, since the liquidity rally, which boosted almost all sectors, has passed. However, the environment continues to be favourable for equities. Prices are driven higher by positive signals from the economy and companies’ earnings. In our company picks, in addition to a solid earnings outlook and moderate valuation, we will prefer growth drivers particularly in emerging markets, and potential of corporate restructuring that would generate shareholder value.
We present our stock picks for the prevailing market conditions in our Finnish equity model portfolio that is published in Nordea’s Netbank for our portfolio service customers.
Tero Wesanko
Senior Strategist,
Nordea Asset Management
