Ex­pert Speak

Dalal Street Investment Journal - - CONTENTS -

We fre­quently en­counter the ques­tion, “Is the In­dian stock mar­ket over­val­ued?’ One of the ways to an­swer this ques­tion is to com­pare In­dia’s stock mar­ket with mar­kets in other na­tions. How­ever, it is very dif­fi­cult to com­pare mar­kets, but we can com­pare the Price-earn­ings ra­tio of the stock mar­ket in­dex to see the rel­a­tive pic­ture.

The PE mul­ti­ple (Price to Earn­ings ra­tio) has been one of the most pop­u­lar ap­proaches to eq­uity val­u­a­tion. PE ra­tio of a com­pany is cal­cu­lated by di­vid­ing the cur­rent mar­ket price of the share with its earn­ings per share (EPS). Thus, PE ra­tio in­di­cates a num­ber which is a unit of com­pany earn­ings that an in­vestor is will­ing to pay. Hence, it could be used to com­pare if the stock is cheap or ex­pen­sive as com­pared to other stocks in the same in­dus­try. Sim­i­larly, we can cal­cu­late PE of the In­dex and we can use the in­dex PE to de­ter­mine the rel­a­tive value.

For the study, we ob­tained Price-earn­ings ra­tio of lead­ing stock mar­ket in­dices of four de­vel­op­ing coun­tries (Brazil, Rus­sia, In­dia and China - BRIC coun­tries) and three de­vel­oped na­tions (United States of Amer­ica, United King­dom and Aus­tralia). For mak­ing mean­ing­ful com­par­i­son, we ob­tained the daily PE and have cal­cu­lated the av­er­age of daily PE for the cal­en­dar year. In case of In­dia, we ob­tained PE ra­tio for both the lead­ing in­dices: Nse-nifty and Bse-sen­sex.

In Ta­ble 1, we ob­serve that dur­ing 2008-2016, the PE for In­dia’s stock mar­ket in­dex gen­er­ally var­ied be­tween 15 and 19. In 2012-2013, Nifty and Sen­sex had the low­est av­er­age PE at 14.8 and 15, and since then the av­er­age has in­creased. The av­er­age PE for Nifty, for the year 2017 (till Novem­ber 2, 2017) was 22, and on Novem­ber 3, 2017, it was 23.7.

A high PE in­di­cates num­ber of years it would take for an in­vestor to re­cover his cap­i­tal if the com­pany gives all its earn­ings to the in­vestor. In a sim­ple lan­guage, if the EPS is at ₹10, and I pay a price of ₹100 to buy the share of a com­pany, the PE ra­tio will be 10, which in­di­cates that it would take 10 years for me to re­cover the ₹100 in­vested, if the com­pany con­tin­ues to earn ₹10 ev­ery year and gives it to me.

In the cur­rent con­text, where Nse-nifty’s PE is 23.7, it would take an in­vestor over 23 years to re­cover the in­vest­ment. This re­cov­ery time can be short­ened if the com­pany’s earn­ings grow sig­nif­i­cantly. The po­ten­tial of growth in earn­ings is a cru­cial in­di­ca­tor, and so we should keep an eye on it.

Rus­sian mar­ket has the low­est PE and looks very at­trac­tive for wealth cre­ation, but as we can see, even his­tor­i­cally, this mar­ket trades at a sin­gle digit PE. In 2007-2008, when Lehman Brothers col­lapsed, the av­er­age PE of USA-S&P500 was 16.8, and Nifty was trad­ing at PE of 20.9, which means In­dia was rel­a­tively ex­pen­sive. Even as on date (Novem­ber 3, 2017), we see that USA-S&P 500 is trad­ing at PE of 22.7, and Nifty is at 23.7, which sug­gests that rel­a­tively the two mar­kets are val­ued nearly the same. How­ever, one needs to keep in mind that earning’s growth po­ten­tial is much higher in the case of In­dian mar­kets as com­pared to the US mar­ket.

On Oc­to­ber 11, 2017, USA-S&P 500 made a new all-time high with PE of 22.87. For In­dia, the all-time high PE for Nifty was 26.83 and for BSE it was 26.33 recorded on Jan­uary 10, 2008. Since In­dian mar­kets are cur­rently trad­ing close to a PE of 24, there is still some head­room for the mar­kets to grow.

For­eign in­sti­tu­tional in­vestors (FIIS) al­ways in­vest in mar­kets which are grow­ing, are fairly priced, and of­fer po­ten­tial for wealth cre­ation. It is im­por­tant that In­dia presents bet­ter growth op­por­tu­ni­ties and ease of do­ing busi­ness to at­tract for­eign funds. On the ‘Ease of Do­ing Busi­ness’ front, In­dia has shown a re­mark­able im­prove­ment in the rank­ing by the World Bank (2018 rank­ing), and has jumped 30 po­si­tions up to grab a place amongst the top 100 coun­tries in the world. This should help In­dia in get­ting more in­vest­ments.

Cur­rently, since the stock mar­kets in

In­dia are driven largely by in­ter­nal funds, if the mar­ket sen­ti­ments re­main pos­i­tive and the gov­ern­ment works to­wards smooth im­ple­men­ta­tion of GST, with a ro­bust in­vest­ment plan in in­fra­struc­ture and bank­ing, we should be able to scale higher. Re­tail in­vestors should con­tinue to look for stocks which have mar­gin of safety and of­fer wealth cre­ation in the long run.

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