T N Ninan: The 40:40 team

WEEKEND RUMINATIONS

Of the roughly 200 stocks that are traded in both the spot and futures markets on the major exchanges in Mumbai, 40 have a price-earnings ratio of more than 40. In contemporary parlance, you could call it Corporate India's 40:40 team, which enjoys the dream-quality valuations now being commanded by some of the members of India's all-conquering 20:20 cricket team. Another 14 have no profits to report; since there is no E, there is no P:E ratio to speak of. But Reliance Petroleum, for instance, is yet to start operations and is already valued on the market at nearly Rs 68,000 crore, marginally ahead of Wipro.

Together, these two categories of companies account for more than a quarter of the most commonly traded stocks in the country. By way of comparison, the 30 stocks that make up the benchmark Sensex have a P:E ratio of a more modest 24, and the 50 stocks on the Nifty have an earnings multiple of 23 "" and even these are high by historical standards. As a telling aside, the infotech stocks that were once the stars of the market are now dogs. Four out of the five big IT companies (TCS, Infosys, Wipro, HCL and Satyam) have P:E ratios that are lower than the Sensex average, the solitary exception being Infosys at 26.

What is one to make of these numbers? First, the India story has moved beyond IT "" many companies in many industries have been clocking growth rates that match those of the tech majors, and they do not seem to have some of the downsides that the tech story has been shown to possess. But is the India story also running ahead of itself, when companies like ABB, the engineering giant, have a P:E of 66 and Bombay Dyeing has 75? Go even higher up the ladder and you have GMR Infrastructure at 147 and Educomp Solutions at 165. What is the sustained performance, come rain or shine, that these companies will have to deliver, in order to justify these stratospheric valuations?

Engineering companies like Siemens, which has a P:E of 58, may enjoy the investment phase of the business cycle, but what if new orders dry up as the cycle turns? Sugar companies like Balrampur Chini have seen their stock price climb by 35 per cent in the space of a month, and enjoy earnings multiples of 70 and more because investors think that the bad phase of the sugar cycle will end and they are therefore doing value-driven buying; but what about the risks inherent in a business subjected to so many crucial government decisions, with all their unpredictability? It is all very well for analysts to talk of a liquidity-driven market and momentum buying, but shouldn't these and other questions be getting asked?

For instance, how many company managements have mastered the art of making announcements about future plans, mostly if not purely with an eye to what this will do to their share price? Track some of the announcements made by members of the 40:40 team, watch the response that has been there in the stock market, and you will get the picture. A friend called the other day to say this is a new kind of P:E, the Price-to-Ego ratio: "If X can command such a high valuation, why am I being left behind? Let me also make some announcements that will get the market excited!" Everyone knows of company managers who tune their business strategy to match the quarterly cycle of results announcements, but this takes matters to the more flighty valuation plane and, it goes without saying, is a more dangerous game to play.

It is not that such valuations are unheard of. Japanese stocks during that country's boom phase, in the 1970s and 1980s, used to enjoy P:E multiples of 50, and many Chinese stocks would qualify for Shanghai's own 40:40 team. Those two examples, and perhaps India's today, underline the point that rapidly growing economies will deliver such high valuations, and many of them will be sustained for a considerable period of time. If the India growth story sustains, these companies will make history. If not, these valuations will be history.