Correction fails to rein in expensive market valuation, say analysts

The benchmark indices have corrected sharply from their record highs but valuations still remain expensive. The Sensex is currently trading at 17.6 times its one-year forward estimated earnings.

                                                                                                                                                                                                           The valuation for the 30-share index is down from more than 20 times in June but still remains above its 10-year average of 15.7 times.

Analysts said the high valuation limits the possibility of sustainable rebound in the market. On the contrary, the valuation zone makes the market more vulnerable to further downside if global sentiment worsens. Expectation of a moderate earnings recovery fails to justify valuation premiums.

“The slowing economy and the low probability of any ‘big-bang’ stimulus do not bode well for the overall growth and earnings outlook. Nifty consensus earnings have been seeing cuts, with the downgrade momentum spreading across stocks. The Nifty company results indicate Q1FY20 EPS (earnings per share) growth of only 5 per cent year-on-year. This contrasts with the steep 20-30 per cent growth rates built into consensus expectations for FY20-21,” said Sunil Tirumalai, head of research, Emkay Global Financial Services.

He added, “Despite the recent correction, we see Nifty valuations not factoring in further earnings risks.”

After the June quarter (Q1) results, most analysts have cut their growth estimates for the ongoing financial year as well as the next one.

The consensus estimated for Nifty earnings growth for FY20 and FY21 have seen a reduction of 3 per cent and 4 per cent, respectively.

CLSA in a note said it had cut its growth forecasts by 5 per cent to 18 per cent earnings growth for FY20, higher than the consensus forecasts 21 per cent growth.

ICICI Securities in a note said it, too, expects modest recovery in earnings.

“Earnings growth trajectory has bottomed out, and we estimate Nifty earnings growth to be 14 per cent in FY20 driven by financial services, industrials, utilities and consumption while auto and metals will drag earnings,” it said in a note on Saturday.

Analysts however believe looking at Nifty valuations could be misleading as several of its components trade far below their long-term averages, while select stocks continue to command huge valuation premium.

The correction in the broader market has been sharper, however, there too valuations have not yet reached the comfort zone.

“Small and mid-cap companies have been pummelled for 18 months, but we would still be unable to say that valuations appear compelling. Our bottom-up computation puts the larger Nifty 500 valuation at 25.6 times trailing earnings. Forward earnings will need to be ratcheted down yet again,” said Sanctum Wealth Management in a note.

Analysts said the government spending could be a key driver for growth. However, and given the fiscal constraints, it is showing signs of fatigue and the government is relying on aggressive tax assumptions. These budgetary constraints also tie-down the elbow room to provide growth stimulus to the private sector — both corporate entities and households, analysts warn.