Sensex valuation hits lowest in 15 months; index underlying EPS up 50%

The valuation of the BSE Sensex, or the price-to-earnings (P/E) multiple relating to the 30 companies comprising the index, has declined to its lowest level in over a year. This is owing to a surge in corporate profitability in the last two quarters, leading to an increase in earnings per share (EPS), and a weakness in the market.

The index is trading at a trailing P/E multiple of 26.8, the lowest since August last year. In comparison, the index underlying EPS reached an all-time high of Rs 2,136 at the end of H1FY22.

With this, the index underlying EPS is up 50 per cent since the beginning of this calendar year and has increased nearly 20 per cent over the pre-pandemic high EPS of Rs 1,795 after the Q3FY20 earnings. 

The index valuation was the highest in March this year when it was trading at a P/E of around 35X. 

The current index valuation is similar to that in the first half of calendar year 2019, when the market had peaked in June that year at a P/E multiple of around 28. However, there was a small rally in the last quarter of 2019 after the cut in corporate income tax rates. 

Equity valuation may have eased in the past six months but the market remains expensive compared to its valuation in the past. The current P/E multiple is only 4 per cent higher than the Sensex's five-year average earnings multiple of 25.8 and around 20 per cent higher than its 10-year average earnings multiple of 22.2. In recent weeks, many foreign brokerages went underweight on Indian equity, citing higher valuations here and lower ones in other emerging markets such as China. 

Market analysts say institutional investors fear a reversal in some of the gains in corporate profits and the index EPS over 12-18 months.

“The bulk of the gains in corporate earnings in the past one year came from cyclical sectors such as metals, mining, oil & gas, and banking. Firms in these sectors profited from a rise in commodity prices and a sharp decline in interest rates. These gains may reverse as commodity prices have started to decline and interest rates are on the rise,” said Dhananjay Sinha, managing director and chief strategist, JM Institutional Equity.

This uncertainty about the trajectory of corporate earnings in India explains the divergence between stock prices and underlying earnings growth seen in recent quarters. 

This is what analysts say could continue to put pressure on stock prices and equity valuations.

This is in complete contrast to the market behaviour in the past when stock prices always stayed ahead of earnings growth. For example, the index had rallied 40 per cent between January 2015 and January 2020 compared to around a 15 per cent rise in the index underlying EPS during the period.

Many analysts, however, discount the possibility of a reversal in the index EPS and expect slower earnings growth at worst.

“There could be some earnings decline in the metal space but it could be more than compensated by modest earnings growth in sectors such as banks and finance, IT and FMCG,” said G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.

This, he said, would translate into a modest 10-12 per cent upside in the broader market by the end of the next calendar year.