Bull run takes Sensex valuation to 2-yr high; earnings per share decline

The recent record-setting rally on Dalal Street has pushed the valuation of BSE benchmark Sensex to a two-year high.

The leading share index is currently trading at a trailing price-to-earnings (P/E) multiple of 25.2 x, up from 23.7x in December last year and the highest since January 2022, when it was at a trailing P/E of 26.9x. The index’s current price-to-book (P/B) value is 3.7x — the highest since November 2021.

The Sensex valuation has witnessed a significant increase in the past two months, with most of the gains coming in this period. The trailing P/E multiple of the index had dropped to a five-month low of 22.45x at the end of October, and the P/B ratio had also decreased to 3.29x, the lowest since May. However, both these values have since risen.

Analysts have attributed this turnaround in equity valuation to a sharp reversal in the bond yield in the US over the past two months. Dhananjay Sinha, head of strategy and research at Systematix Institutional Equity, explained: “The valuation rerating of equities is largely due to a sharp decline in the risk-free rate, which is the yield on US 10-year Treasury bond. The decline in US bond yields has triggered a global rally in risk assets, and the Indian equity market has strongly participated in this rally.”

The yield on 10-year US government bonds has fallen nearly 100 basis points since the end of October — from 4.93 per cent to around 3.9 per cent. During the same period, the BSE Sensex has rallied by 11.7 per cent, its trailing P/E has risen by 13 per cent, and there has been a similar rise in the index’s P/B ratio.

But the index's underlying earnings per share (EPS) — which tracks the combined net profit of the 30 companies that are part of it — has declined by 1.1 per cent in this period, from Rs 2,858 at the end of October to Rs 2,825 currently.

This recent rise in the Sensex’s valuation follows a nearly three-year period of steady decline in valuation, during which corporate earnings grew much faster than stock prices, leading to a decrease in the P/E and P/B ratios. The index’s P/E multiple fell from a record high of 34.4x at the end of March 2021 to 22.4x at the end of October this year. In contrast, the benchmark gauge rallied 29 per cent, while its underlying EPS nearly doubled from Rs 1,441 at the end of March 2021.

According to Systematix’s Sinha, the recent valuation rerating of Indian equities is reminiscent of the 2014-2019 period, when there was a steady rise in the index’s valuation, while corporate earnings were growing in the low single digits and bond yields were low. The index’s trailing P/E multiple increased from 17.8x at the start of January 2014 to 28x at the end of December 2019. During this same period, the Sensex’s underlying EPS grew by just 27 per cent cumulatively, translating into a compound annual growth rate (CAGR) of just 5 per cent. 

By comparison, the index doubled in that period, from 21,000 at the start of 2014 to 41,250 at the end of December 2019.

“Recent macroeconomic data and the sharp decline in the bond yield suggest that we could be back in the era of slower earnings growth, lower interest rates, and elevated equity valuations,” said Sinha.

However, others are betting on faster earnings growth in the future. G Chokkalingam, founder & CEO of Equinomics Research, argued: “The reversal in the interest-rate cycle could translate into lower interest outgo for corporates and households, boosting corporate profits and household disposable income.”