HIGH VALUATIONS... BSE’s 30-share Sensex P/E@19.06 times

High valuations fail to deter equity investors Based on the one-year forward P-E ratio, the Sensex is trading at a 21.4% premium to its five-year average

Mumbai: Third quarter corporate earnings may have fallen short of Street expectations, but that’s unlikely to deter investors betting that an imminent economic rebound will translate into higher profits, notwithstanding expensive stock valuations. While the benchmark S&P BSE Sensex is trading at a more than 20% premium to its historic average, sectoral indices like the S&P BSE Capital Goods index and the S&P BSE FMCG index are looking more expensive. Based on the one-year forward price-to-earnings (P-E) ratio, BSE’s 30-share Sensex is trading at 19.06 times—a 21.4% premium to its five-year average of 15.7 times. 

It is also far more expensive than the MSCI EM (emerging markets) Index, which is trading at 12.03 times one-year forward earnings. While the broader markets and individual stocks did see some selling pressure following the disappointing earnings season, some investors say that high valuations may not be a deterrent to the stock run-up. Earlier this month, a Mint analysis of 315 BSE 500 companies—for which comparable data is available for at least 25 quarters—showed aggregate net sales rose at a mere 0.25% from a year ago, the slowest pace since the quarter ended March 2010. 

Aggregate net profit for this sample dropped 4.65%—the worst showing since the quarter ended March 2013. Of these 315 firms, 156 missed Bloomberg’s consensus estimates for their net profit, while 111 beat the estimates. There were no consensus estimates for 48 companies. “Stock markets are forward looking and are betting on much higher growth rates a few quarters down the road,” said Samir Arora, founder and fund manager at Helios Capital Management Pte. Ltd.

 “The macro backdrop for Indian equity markets is very supportive and therefore, markets are rightfully ignoring the very short term performance,” Arora said in an emailed response from Singapore to queries from Mint. Foreign institutional investors pumped in a net of $2.9 billion in Indian equities in January, but have been net sellers to the tune of $392 million so far in February. Domestic institutional investors, on the other hand, sold a net of Rs.7,881.8 crore of shares in January, but bought a net of Rs.2,557.9 crore of the asset class this month. 

The Sensex has gained 6.3% so far this year, adding to the 29.9% gain seen in 2014. On Friday, it closed 0.78% lower at 29,231.41 points. It is only 613 points away from reaching a new high. India’s economic growth is projected by the government to accelerate to 7.4% in the year to 31 March compared with 6.9% last year, based on a new way of calculating gross domestic product, and at this level it is estimated to be on par with China, the world’s fastest growing major economy. To be sure, there is a debate on how to read the new data. Under the previous series, growth in the current fiscal year had been expected at 5.5%. 

The stock market has been rallying since the run-up to the April-May general election that gave the National Democratic Alliance under Narendra Modi a comfortable majority in the Lok Sabha. Among the sectoral indices, the capital goods index is currently the most expensive, trading at 39.31 times one-year forward earnings, according to Bloomberg estimates. This is around 89.7% higher than its five-year average of 20.72 times. “The capital goods sector in India is trading at high P-E multiples on high expectations of a material upturn in capital expenditures following the Modi victory in Lok Sabha elections,” said Darshan Bhatt, co-founder and deputy chief investment officer of US-based Glovista Investments Llc. “However, since the P-E is computed using trough earnings in this sector, it does not necessarily reflect over-valuation. 

It is anticipating an earnings growth of 50% over the next 12 months, which is achievable provided corporate capex picks up at a sufficiently high pace,” he said in an email from New Jersey. Bhatt added that across the global capital goods segment, he favoured Japanese and German companies. Within emerging markets, besides Indian capital goods companies, he favours the purchase of Chinese railroad firms and Brazilian airplane manufacturers. “We favour capital goods companies domiciled in those markets as they are not only growing earnings in their respective domestic markets but also represent exporter-oriented corporates domiciled in countries whose currencies remain on strong weakening trends versus the US dollar and Indian rupee,” Bhatt said. 

Others agreed that the high valuation of capital goods shares did not make them unattractive. “The premium for capital goods is relatively higher, due to opening up of opportunities. It will be rationalized once the economy starts expanding, and the projects start being executed,” said Deven Choksey, managing director and chief executive officer of KR Choksey Shares and Securities Pvt. Ltd, adding that activity in the capital goods sector could pick up in the next two-three quarters. Consumption-related stocks have traditionally enjoyed higher valuations, and it is not different this time. 

The BSE FMCG index trades at 37.09 times one-year forward P-E, up from its five-year average of 29.33 times, while the BSE Consumer Durables index trades at 38.28 times, above its five-year average of 22.66 times. FMCG is short for fast-moving consumer goods, or packaged consumer goods. Of the top 10 most expensive stocks in the BSE 100 basket, eight are consumption-linked stocks. These are United Spirits Ltd, United Breweries Ltd, Nestlé India Ltd, Hindustan Unilever Ltd, Asian Paints Ltd, Dabur India Ltd, Titan Co. Ltd and Godrej Consumer Products Ltd. “I strongly believe that the consumption space is certainly overpriced. 

The current demand is factored in the valuations. However, the earnings growth isn’t justifying the high price,” said Rakesh Rawal, head of private wealth management at Anand Rathi Financial Services Ltd. According to Bhatt of Glovista, the consumer sector globally, including India, is trading at expensive valuations owing to demand for defensive sectors. “In general, we believe consumer sector stocks globally are richly valued and we opt not to own them across the board,” he said. On the flip side, the S&P BSE Oil and Gas index trades at the lowest one-year forward P-E of 11.66, a tad higher than its five-year average of 11.35 times. 

The S&P BSE Metal index trades at 12.21 times one-year forward earnings, but is still above the five-year average of 9.84 times. “For a variety of reasons, we do not generally buy commodity stocks and state-owned companies. In oil sector, we get commodity and state-owned stocks all in one, and that is an even bigger big no-no for us,” said Arora of Helios.

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