Mar 20, 2008

Market View - Sensex hasn't got its valuation it deserves - ET

The long-term trend is pointing towards under valuation of the Indian equity market. The market, as measured by Price-to-earning ratio (PE) of the Sensex has just about pierced the long-term trend line.

At the current valuation, it is quoting at a one-year forward of 16, little less than the earnings growth rate that Sensex companies have managed since 1991. If the theory of market returns chasing earnings growth is to be believed, this is just about time for accumulation for those looking at the longer haul. Since 1991, while the Sensex has grown at CAGR of 15.5%, its earnings grew at a rapid 16.6% per annum.

In the past two years, the market went up partially on the back of 'PE expansion'. It meant PE of the Sensex was getting priced higher than usual, since the market expected faster growth in earnings. But with the current correction, while valuations have been 'cleansed' of such expectations, there are probably returns to be made if investors were to take a leaf out of historical happenings.

After all, Indian economy has been growing at a brisk pace ever since liberalisation. And during that period, the rate of earnings growth of the Sensex has grown higher than the nominal GDP growth rate (current prices) of the economy.

While Sensex earnings averaged 15.5%, it was 13% for the economy. While the January IIP growth figures (5.4%) weren't encouraging, even matching the long-term averages could mean getting 16% returns from the Sensex.

Arguably, there have been four equity market cycles that India has witnessed ever since economic liberalisaion. It witnessed a peak in 1992, followed by one in 1996, 2000 and then the 20,000 plus levels that it witnessed recently. And if one were to analyse the Sensex earnings and its returns since the past peak of April 2000, it seems the Sensex has not got its valuation it deserves.

Since April 2000, the Sensex has multiplied 2.7 times while its earnings multiplied 3.6 times. While the market obviously gazes into the immediate future to give current valuations, it is a million dollar question whether it is missing the big picture.