No matter bull or bear market, PE stands tall

Dalal Street watchers have been wrestling with a major dilemma for a few years now: the price-to-earnings (P/E) multiple, a traditional value gauge, has defied all logic to stay elevated and yet the market has delivered solid returns in phases.
When Indian stocks were surging till the middle last week, any talk of market valuations reaching uncomfortable level would meet with a cold gaze.

Sensex has come down some 117 points over the past five sessions amid concerns over a spike in crude oil prices, weaker global growth, uncertainty surrounding the domestic elections and worries ahead of the March quarter earnings seasons.


On Wednesday, the valuation multiple of BSE Sensex hovered at its highest level in 11 years after the recent rally lifted its price-to-earnings (P/E) multiple to 28 times by March end. Last time the 30-pack quoted around this mark in January 2008, the market was witnessing a raging bull run.

Strong inflows from overseas portfolio managers fuelled a solid dash in Indian stocks for two months, helping the BSE benchmark to advance nearly 7 per cent and hit its all-time high of 39,270 on April 3. Its last all-time high was 36,256, hit on January 31 this year.

Analysts are not ready to slow down investment looking at the high PE multiple. Their refrain: this ratio should not be looked at in isolation.

“Just looking at PE multiple can be misleading. Valuations have to be seen on many fronts. The ratio is looking optically higher due to decades of subdued earnings. Once the problem of deleveraging of corporate balance sheets gets over, capacity utilisation of the private sector rises to 85-88 per cent levels, issues related to asset quality and liquidity problems resolved, then earnings will play catchup. At present, earnings yields of equities are still looking attractive compared with other fixed income,” said Amar Ambani, President, Head of Research at Mumbai-based YES Securities.

Foreign portfolio investors infused more than Rs 51,000 crore in Indian equities through February and March, after having sold shares worth Rs 4,262 crore in January.

Some say the PE itself may have undergone a transformation. “The E (earning) in the PE is at a trough. Once it recovers, primarily on strength from corporate bank earnings, the adjusted PE will be much lower,” says Prabhakar Kudva, Co-Founder and Director of Samvitti Capital.

Compositions of Indian equity benchmarks have changed drastically in recent times. Today they have many high-quality companies that generally trade at high PEs given their strong return ratios and sustainable growth prospects. “We are not worried about high valuations in the market,” said Kudva.

As of March 29, private sector lenders Axis Bank and ICICI Bank were trading at price-to-earnings ratios of 203 times and 75.30 times, respectively, while some other index stocks like Asian Paints, HUL, Kotak Mahindra Bank, Bajaj Finance and Tata Motors traded at PE values ranging from 35 to 67 times.

At the same time, Coal India, ONGC, Tata Steel and Vedanta traded PEs of 9.6 times, 7 times, 6.9 times and 6.2 times, respectively.

The Sensex PE has remained elevated for quite some time now, defying traditional stock market equations. It was at 20 times in February 2015 when worries over China debt, the US business cycle, Brexit, Italy’s debt crisis, India’s demonetisation and ballooning bad loans of PSU lenders were haunting investors.

The PE has persistently stayed elevated ever since and yet managed to deliver over 31 per cent returns till date.

Some analysts say the price-to-book value may be reflecting a better picture. This barometer ruled at over 3 times on April 9, far below the 6-times mark where the market traded at the peak of the bull market in 2008.

Edelweiss Securities says Indian equities are poised for some dramatic growth as economic indicators have hit historical troughs and are likely to inch up from here on.

“This improvement can be the likely basis for an already expansionary fiscal and an expectedly dovish monetary policy. Thus, India seems ready for Reflating the bull,” the brokerage said.

“Higher nominal growth is likely to result in better revenue growth. In confluence with basing out of banking profitability, we expect the earnings recession to limp out and give way to better earnings growth,” the brokerage said in a report.

Nifty faced many downgrades in FY19 as its EPS growth slowed to just 9 per cent year-on-year in the first nine months. Infrastructure and capital goods along with IT were the only sectors that sprang earnings surprises, leading to upgrades.

Auto stocks faced repeated downgrades as a muted demand environment troubled the sector all through 2018-19. “According to consensus, India Inc would witness earnings growth at 16 per cent CAGR in next three years, significantly breaking out of the current trend. With credit conditions improving and nominal GDP reviving, we should see upgrades going ahead,” Edelweiss said.