Submissions – Financial Sector Background on the Australian Listed Equity Market

As of August 2021, the capitalisation of the listed Australian equity market was about $2.5 trillion (US$1.8 trillion), which is smaller than that of the largest markets overseas (Graph 1). However, as a ratio to GDP, stock market capitalisation stands at around 140 per cent, which puts Australia around the middle of this group, comparable to Japan and the United Kingdom (Graph 2).

The equity market is the largest securities market in Australia (Graph 3, updated from Mathews (2019)). This has not always been the case – the market for government and government-backed bonds has been much larger in the past and, as measured by securities outstanding, was at around the same level as the market for equity in 1990. The equity market expanded rapidly through the 1990s, supported by the privatisations of the Commonwealth Bank and Telstra, demutualisation of several financial institutions and an increased supply of capital to the share market because of compulsory superannuation (Lowe and Gizycki 2000).

By sector, financial corporation and resource stocks are the largest categories of the Australian Stock Exchange (ASX), currently accounting for around 30 per cent and 20 per cent of market capitalisation, respectively (Graph 4). Within other industries, the largest categories are healthcare (11 per cent of the index) and consumer discretionary (8 per cent). The relative size of these industry sectors has changed over time.

The 10 largest listed companies have accounted for around half the market capitalisation of the top 100 stocks on average from 1917 until 2018 (Graph 5). The share of market capitalisation of the 10 largest companies peaked during periods of high commodity prices such as the 1960s and 1970s. This is also evident in alternative measures of concentration, such as Herfindahl-Hirschmann indices, which are higher when concentration is higher. The resources and financial sectors were, and continue to be, notably more concentrated than the rest of the market. Measures of concentration have declined slightly over the past 20 years or so. Internationally, among similar-sized stock exchanges, the level of concentration seen in Australia is not unusual (Kohler 2018).

The make-up of the top 10 companies has been little changed over time: of the top 10 companies in 1917, five were still in the top 10 at the end of August 2021 (Table 1). In contrast, only one of the top 10 US companies in 1917 was still in the top 10 100 years later (Kauflin 2017). Consistent with this, Australia's listed corporations are relatively older than those in other major equity markets: weighted by market capitalisation, the average listed company in Australia is around 105 years old, compared with 77 years in Japan, 82 in the US and 95 in the UK (Graph 6).

Of the roughly 2,000 listed companies on the Australian Stock Exchange, around 150 are foreign headquartered.^[1] About 50 of those companies have primary listings on other exchanges, such as News Corporation and Unibail-Rodamco-Westfield. The two largest mining companies listed on the Australian Stock Exchange, Rio Tinto and BHP, are dual-listed, meaning there are two separate companies, one listed in Australia and one listed in the another country (the United Kingdom in the case of these companies) with an equalisation agreement in place. The equalisation agreement ensures that a share in each respective company entitles the owner to receive the same dividend payments and voting rights. BHP has recently proposed to unwind its dual-listed structure, moving to a primary listing in Australia.

Foreign investors account for about one-third of the value of holdings of Australian listed equity (Graph 7). Over the past 15 years, the share accounted for by superannuation funds has increased strongly, while the share accounted for by direct household ownership has fallen.

Equity markets generally offer a higher average return than safe assets, such as bonds, because investors need to be compensated for the additional risk that is associated with equities. On average, in Australia the realised equity premium – the return on equity relative to the return on a 10-year government bond over a 10-year period – has been broadly comparable to that in the United States (Graph 8).

The dividend payout ratio for equities is the proportion of profits paid out as dividends. On average around 65 per cent of listed company earnings were paid to investors in the form of dividends from 1917 until the present, although this has varied over time (Graph 9). The introduction of franking credits in the 1980s in Australia contributed, at least in part, to the relatively high dividend payout ratios since the early 1990s (Bergmann 2016).

Initial Public Offerings (IPOs) are a source of finance for companies' first listing. However, in Australia the dominant form of capital raising is by companies that are already listed raising further funding (Graph 10). Since 2008, an average of $5 billion per year has been raised through IPOs, while other raisings accounted for an average of almost $43 billion. The amount raised fluctuates over time, with increased issuance seen in the immediate aftermath of the global financial crisis and as the COVID-19 pandemic worsened in 2020.

The price-to-book ratio is a valuation metric reflecting the premium the market is willing to pay for a company's assets over their accounting cost. In a highly simplified economic model, this ratio should not deviate much from one. If it were to do so, a company could invest capital in some business, float it on the stock exchange and make a capital gain. If that occurred on a large enough scale, there would be forces that would push the ratio towards one. The supply of new equity on the market could bring equity prices down, and the extra supply in the product market would reduce profits, and thereby reduce valuations.

However, there are reasons for the price-to-book ratio to deviate from one. For example, it can be higher because companies might have market power in their product markets. If new companies cannot be established to compete because there are some barriers to entry, then high valuations can persist. But there are other reasons price-to-book ratios might be high. For example, unrealised capital gains on assets can increase the price-to-book ratio.

In Australia, measures of price-to book valuations have increased since 1980, reflecting an increase between 1980 and 2000 (Graph 11).

Endnotes

Data from the July 2021 ASX Foreign Entity Report found at <https://www2.asx.com.au/listings/how-to-list/listing-requirements/foreign-entity-data> [1]

References

Bergmann M (2016), ‘The Rise in Dividend Payments’, RBA Bulletin, March, pp 47–56.

Kauflin J (2017), ‘America's Top 50 Companies 1917-2017’, Forbes, 28 September. Available at <https://www.forbes.com/sites/jeffkauflin/2017/09/19/americas-top-50-companies-1917-2017/>.

Kohler M (2018), ‘The Long View on Australian Equities’, 31st Australasian Finance and Banking Conference, Sydney, 13 December.

Lowe P and M Gizycki (2000), ‘The Australian Financial System in the 1990s’, in S Shrestha and D Gruen (eds), The Australian Economy in the 1990s, Proceedings of a Conference, Reserve Bank of Australia, Sydney, pp 180–215.

Mathews T (2019), ‘The Australian Equity Market over the Past Century’, RBA Research Discussion Paper, June.