 "Sensex gets expensive for 4th straight year")
For the first time in 20 years, market valuation has risen for a fourth straight year in 2015. The BSE benchmark Sensex is now trading at a little under 20 times the underlying earnings of its 30 constituent companies, compared with a price-earning multiple of around 19 times at the end of last calendar year. The benchmark valuation (P-E) has increased from 16.4 times — the low of December 2011 —to 19.6 times at present.
This is the longest period of valuation expansion for the index since 1996. The previous record was seen during the boom years of 2004-07, when the Sensex’s earning multiples had expanded from 17 times at the end of 2004 to a peak of 27.7 times by the end of 2007. This boom was followed by a crash the following year, when valuation dipped to a 13-year low of 12.4 times by the end of 2008.
The analysis is based on the year-end Sensex value and the index’s trailing price-to-earnings multiples for the past 20 years. The index’s underlying earnings (per share) have been calculated by inverting the P-E ratios for the respective years.
This is the longest period of valuation expansion for the index since 1996. The previous record was seen during the boom years of 2004-07, when the Sensex’s earning multiples had expanded from 17 times at the end of 2004 to a peak of 27.7 times by the end of 2007. This boom was followed by a crash the following year, when valuation dipped to a 13-year low of 12.4 times by the end of 2008.
The analysis is based on the year-end Sensex value and the index’s trailing price-to-earnings multiples for the past 20 years. The index’s underlying earnings (per share) have been calculated by inverting the P-E ratios for the respective years.
The current rally has lasted longer, despite poor earnings growth, than during the previous boom. During 2004-07, Sensex companies’ underlying earnings had grown at a compound annual rate of 23 per cent. In contrast, the underlying earnings have declined 10.1 per cent in 2015; and a third of the index companies (11 out of 30) reported profit declines during the 12 months ended September this year. Overall, the underlying earnings of the index companies have grown at 8.7 per cent CAGR since the close of 2011.
The index has appreciated at the rate of 13.7 per cent during the period. Investors have earned double-digit returns in the past four years, despite a six per cent fall in the benchmark index during the current calendar year.
The present year has also seen the BSE Mid-cap and the BSE Small-cap indices outperforming the benchmark Sensex for a second straight year, the first such occasion in a decade. In the past, these indices used to beat the benchmark in alternate years — an outperformance of the Sensex was followed by a better show by mid- and small-cap shares the next year, and vice versa the following year.
In 2015, the BSE Mid-cap and Small-cap indices have risen 5.9 per cent and 5.3 per cent, respectively, against a six per cent decline in the benchmark index. Last year, these indices had risen 54.7 per cent and 69.2 per cent, respectively, to beat the benchmark Sensex, which appreciated 30 per cent.
The growing mismatch between corporate earnings and stock market valuations raises the prospects of a market correction in the new year; quite a few analysts are suggesting that investors should remain cautious.
“The rally is driven by the hope of an imminent revival in the economy and corporate earnings. In the previous two quarters, corporate earnings have disappointed, and created a wedge between valuations and underlying fundamentals. I will advise investors to be cautious in the next year, to avoid surprises,” says G Chokkalingam, founder & CEO, Equinomics Research & Advisory.
While Chokkalingam remains hopeful of an earnings revival in 2016, he doesn’t rule out a nasty surprise, given deflationary pressure in the world’s major economies. “Six countries have pushed interest rates into the negative zone, to fight deflationary pressure in their economies. This is a big overhang on India Inc, and we have to be watchful,” he adds.
Others blame it on last year’s elevated base, besides unexpected earning contraction for a few large companies. “The current high valuation is an optical illusion, as earnings peaked last year due to the festival season falling in the September quarter. This year, the festival season was pushed to the December quarter, making year-on-year comparison difficult,” says Anoop Bhaskar, head (equities), UTI Mutual Fund. The current Sensex earnings capture corporate results for the 12 months ended September this year.
Bhaskar expects the valuation ratio to “normalise” in 2016. “Valuations have peaked and will moderate as the base effect of poor earnings and lower commodity prices kicks in during the new year,” he adds. Thus, investors could expect faster earnings growth in 2016 because of these reasons, but experts say stock prices are unlikely to rise as rapidly. This, in turn, will result in a reduction of the P-E multiple. It is something that is unlike what we have seen in the past few years, when nearly half the stock returns came from valuation expansion or stock re-rating, rather than earnings growth.
