Sensex drops 800 pts: Are stocks overpriced?
India’s stock markets have experienced overheating
NEW DELHI: The BSE S&P Index fell by 806.47 points to close at 35,169.16 on Thursday. The index has lost 9.6% of its value since August 28 when it reached an alltime high of 38,896.63. Part of the reason for the fall is adverse developments on the external front such as rising crude prices, fall in the value of the rupee, and rise in interest rates in developed markets. However, it is also important to ask the question whether the current valuation of the Indian stock market is justifiable?
There is no denying the fact that speculation is an important element of stock market movements. However, what differentiates stock market speculation from an activity such as gambling is that the former is pegged to economic performance of companies whose stocks are traded.
›
We are announcing a cut of ₹2.50 per litre in the prices of petrol and diesel in UP. Although it will have adverse impact on state’s revenue we are taking the decision in the interest of people. The state govt will lose a revenue of ₹4K cr per year and we will try to generate this from other sources YOGI ADITYANATH, UP CM
NEW DELHI : The BSE S&P Index fell by 806.47 points to close at 35169.16 on Thursday. The index has lost 9.6% of its value since 28 August 2018 when it reached an all-time high of 38896.63. Part of the reason for the fall is adverse developments on the external front such as rising crude prices, fall in the value of the rupee, and rise in interest rates in developed markets. However, it is also important to ask the question whether the current valuation of the Indian stock market is justifiable?
There is no denying the fact that speculation is an important element of stock market movements. However, what differentiates stock market speculation from an activity such as gambling is the fact that the former is pegged to economic performance of companies whose stocks are being traded. Even if speculation drives share prices up in the short term, a poor economic performance is bound to puncture the euphoria in the long term. The price-earnings multiple (P-E ) is a useful indicator to measure this. The P-E is the multiple of earnings per share of a company that will add up to its share price. Earnings per share is a function of profits made by the company.
A comparison of P-E multiples with stock market movement shows that the recent bullphase in Indian stock markets was based more on euphoria than economic performance, as the P-E multiple has increased continuously. (Chart 1)
The same holds international comparisons as well. The current value of P-E multiples for the BSE S&P index is the highest among major stock indices in the world. India’s other major stock index Nifty is ranked third in the list. (Chart 2) The ratio of current P-E multiple and average P-E multiple for the last five years for the BSE S&P index and Nifty are the second and third highest in the list. This suggests that India’s stock markets have experienced more overheating than most international peers in the recent period.
If the investors took longterm P-E multiples as the benchmark for investing in stock markets, we might be headed for much bigger losses in the near future. To be sure, other factors might change investor behaviour as well.