Now that the S&P BSE Sensex has breached 30,000 and is at a new life high, is the stock market too hot to handle? Or is it just warming up to create new records?
To gauge this, it is best to look at the valuation multiple at which the index trades, rather than the absolute index level. As per BSE data, the Sensex currently trades at a price-earnings (PE) multiple of 22.5. That is, investors are currently paying ₹22.5 by way of stock price for every rupee of profits earned by the Sensex companies in the last 12 months. Views are still sharply divided on whether 22.5 is a pricey valuation or a reasonable one.
The bull case
Bullish brokers and fund managers assure us that a Sensex PE of 22.5 isn’t cause for alarm. For one, they argue, big market reversals in the past have unfolded at a much higher multiple. In February 2000, the Sensex PE was 24.3 before the dotcom bubble burst. In December 2007, it hovered at about 27 before the global credit crisis precipitated a meltdown.
Two, the current PE appears high because the denominator — earnings — is unusually depressed. Profits for Sensex firms have increased at just 5.4% annually in the six years from FY11 to FY17. Once earnings growth reverts to 15% or so, they reckon, the PE will collapse.
As stock prices are all about expectations, they point out, the forward PE multiple (the price per rupee of next year’s earnings) is the must-watch indicator, rather than the historical one. So, assuming that Sensex firms expand their profits at 16-17 % for FY18, the Sensex forward PE is 17.8 times. That’s in line with the 20-year average of 18 times.
The other argument is that even if the PE is elevated, other valuation indicators such as market cap-to-GDP and Price-to-Book Value (P/BV) suggest a moderately-valued market.
Of course, the clinching argument is the flood of liquidity, both from foreign and domestic investors, that is chasing the ‘India story’ and propelling stock prices higher.
The bears, however, have credible counter-arguments to all this. For starters, even if the PE of 22.5 has room to expand before the inevitable correction, the downside to markets from here would be higher than the upside. And who can catch the exact tipping point? It is true that Sensex earnings growth has been unusually depressed in the last six years. But what’s the guarantee that it will normalise this year? For the last three years, brokerages and analysts have optimistically ‘modelled’ Sensex profit growth of 15-20%, only to sheepishly downgrade their estimates by the year-end and roll them forward.
In April 2015, analyst estimates for Sensex earnings for the year were at more than ₹1,750 – a 20% growth over the previous year. Actual earnings for the year stood at just ₹1,385. Undaunted, in April 2016 they again projected a 20% expansion to ₹1,670 for FY17. But the results for the first nine months suggest that the number may just top ₹1,430.
While the first half of FY17 was a damp squib, December quarter numbers have offered hope that growth for corporate India is finally shifting to a higher gear. But the past record of analysts in predicting earnings still injects a healthy dose of doubt into their estimates of ₹1,685 to ₹1,700 for FY18.
As to other indicators such as P/BV or liquidity, that’s akin to shifting the goalposts in the middle of the game. Bearish folk remind us that in the long term, stock prices are slaves to earnings growth. So if corporate India fails to deliver on that much-awaited profit rebound, why would foreign and domestic investors continue to sink in new money?
So, with both camps sticking to their guns, what should a lay investor do? Well, panicking and exiting all your equity investments can lead to missed opportunities. Who knows if that earnings rebound is just around the corner?
But making out-sized bets on equities because you are bedazzled by recent gains is equally fraught. Phasing out your investment through vehicles such as Systematic Investment Plans seems to be the best bet. Sticking to diversified funds and large-cap stocks may be safer than playing sectors or small businesses. And as long there’s a bear camp in the market that is warning of over-heating, you can rest assured that we’re not in bubble territory. It’s when the last bear switches camp that the real bear market will begin.
Published - April 30, 2017 10:07 pm IST
