Still more steam left

The Sensex PE at 8500 is lower than what it was last December

The Sensex may have closed at record levels of 8500 points, but in terms of PE-based valuations, market indices are nowhere near new highs. On the contrary, the Sensex's current PE of 17.5 times is the lowest when compared to previous rallies in the market.

PE valuations were about 25 times in tech boom in 1999-2000 and as much as 50 times in the market bubble in the mid 1990s. That fact has been tom-tommed by the bulls for quite some time.

But what's interesting is that although market indices have risen at a fast pace this year, PE-based valuations haven't. The Sensex's current PE of 17.5 times is actually lower than the level last December.

According to the Bombay Stock Exchange, the average PE for December 2004 stood at 18.15 times, about 4 per cent higher than current levels. That's surprising since the Sensex has jumped about 30 per cent since December 2004.

Evidently, earnings growth in the previous 12 months (till June 2005) has outpaced growth in the market index. While this gives a great deal of comfort, it needs to be noted that analysts expect Sensex earnings growth to decelerate in two years to about 15 per cent, compared with a growth of 25-30 per cent in the past few years.

Besides, although the Sensex PE itself may look reasonable, that may not be the case with all of its constituents. Some of them, such as Bharti and Infosys trade at rather high trailing PEs of 40 and 34 times respectively.

Of course, these companies are expected to grow earnings at a faster pace, relative to the market, but even then expecting them to maintain an average earnings growth of 30-40 per cent in the next few years looks like an uphill task.

Things are worse in case of mid- and small-cap stocks. NSE's CNX Midcap index enjoys a PE of 19.6 times, much higher than Nifty's PE of 15.99 times. While the Sensex and the Nifty do not give the impression that the markets are overheated, the peripheral indices certainly do.

Employment growth

The Reserve Bank of India's Handbook of Statistics on Indian Economy has some interesting data on employment. The data on employment in the public sector and the organised private sector makes the well-known point that employment in the organised sector has been declining.

This data show that employment in the public sector has declined from 195.6 lakhs in 1996-97 to 185.8 lakhs by 2002-03, the latest year for which the numbers are available.

Similarly, employment in the organised private sector went down from a maximum of 87.5 lakhs in 1997-98 to 84.2 lakhs by 2002-03. Of course, 2002-03 was not a good year for industry, and it's possible that employment, at least in the organised private sector, may have picked up since then.

But what's interesting is that there has been no such decline in employment in the Small Scale Industries sector. Data on the performance of the SSI sector in the Handbook show that the number of people employed has been consistently rising, and stood at 282.9 lakhs in 2004-05.

If we take the period between 1997-98 and 2002-03, employment in the SSI sector increased from 213.2 lakhs to 282.9 lakhs, a rise of 69.7 lakhs. That increase was more than enough to offset the decline in employment in the organised sector.

In short, the data proves the anecdotal evidence that employment has been growing in the manufacturing sector, and it is only in the organised sector that employment has declined, probably due to the restrictive labour laws.

Nagarjuna Construction

The Nagarjuna Construction Company stock gained 3 per cent to Rs 230 on reports that the company has bagged a Rs 253 crore crore order in north India from NHAI.

Prior to today's rise, this stock has risen about 33 per cent over the past six weeks compared with a 8 per cent gain in the Sensex "" investor sentiment has been bouyant thanks to several contracts won by the company in the last few months, including the Rs 89 crore order for construction of flyovers in Patna.

However, contrary to investor expectations, margins from such NHAI projects are not very high and are estimated at about 5 - 6 per cent, point out analysts.

Although the company has not specified the terms of this contract, construction companies typically protect their margins from rising input costs like cement via escalation clauses.

Meanwhile, lower steel prices on a y-o-y basis in the June quarter helped the company improve its margins while implementing projects in sectors like irrigation and buildings "" overall operating profit margin rose 31 basis points to 7.74 per cent.

The street appears to has already factored in the current growth opportunities for the company given that the stock trades at about 24 times estimated FY06 earnings.

However, with the India Infrastructure Report estimating total infrastructure spending of around $ 130 billion over the next five years, investors would be clearly eyeing the long term growth potential of the company.

With contributions from Mobis Philipose and Amriteshwar Mathur