Broader mar­ket val­u­a­tion at all-time high of 30.5x

Valu­a­tions are steeper for for­eign in­vestors, as spread be­tween earn­ings yield and US trea­sury yield is at a record low of 0.93%

Business Standard - - FRONT PAGE - KR­ISHNA KANT

Asteady rise in mar­ket cap­i­tal­i­sa­tion in the past three years, cou­pled with stag­nant cor­po­rate earn­ings, has pushed up the val­u­a­tion of the broader mar­ket to an all­time high even as the bench­mark in­dices like the S&P BSE Sen­sex and Nifty50 still look cheap, com­pared to their pre­vi­ous highs. A broader sam­ple of large-, mid- and small-cap stocks are now trad­ing at 30.5 times their com­bined net profit in the past 12 months.

This val­u­a­tion is nearly 30 per cent higher than the Sen­sex com­pa­nies’ cur­rent price-to-earn­ings (P/E) mul­ti­ple of 23.5. The in­dex com­pa­nies’ val­u­a­tion had peaked at the trail­ing P/E mul­ti­ple of 28 at the end of De­cem­ber 2007, a week be­fore the start of the big 2008 mar­ket cor­rec­tion. The broader mar­ket was val­ued at 22x at the end of De­cem­ber 2007, or about a fifth lower than the bench­mark in­dices.

The com­bined mar­ket cap­i­tal­i­sa­tion of all listed com­pa­nies is up 71 per cent in the past three years (since March 2014), against a 1.5 per cent de­cline in their com­bined net profit dur­ing the same pe­riod. In all, stock prices have dou­bled, on av­er­age, since the be­gin­ning of the cur­rent bull run in March 2013, against a mar­ginal 0.6 per cent cu­mu­la­tive growth rate in net profit dur­ing the pe­riod.

The sam­ple com­pa­nies’ com­bined net profit grew from ~3.52 lakh crore in FY13 to ~3.54 lakh crore in FY17. In com­par­i­son, their com­bined mar­ket cap­i­tal­i­sa­tion jumped from ~53.7 lakh crore at the end of March 2013 to ~108.1 lakh crore at the end of mar­ket trad­ing on July 12, 2017.

The broader mar­ket is, how­ever, still cheap by around 50 ba­sis points (bps) on priceto-book value, com­pared to the pre­vi­ous high in March 2008. But, this is hardly com­fort­ing, given that the re­turn on net worth (or eq­uity or share­hold­ers’ funds) is now less than half at 9.3 per cent, com­pared to 19 per cent in FY08.

The anal­y­sis is based on a common sam­ple of 802 com­pa­nies from the BSE 500, BSE MidCap and BSE Smal­lCap in­dices. It ex­cludes public sec­tor oil-mar­ket­ing com­pa­nies and cycli­cals such as Vedanta and Tata Steel, which have re­ported large ex­cep­tional losses in the past three years.

In­clud­ing these cycli­cals, the com­bined mar­ket cap­i­tal­i­sa­tion is up 99 per cent since March 2013, against 12 per cent cu­mu­la­tive growth in earn­ings dur­ing the pe­riod.

Valu­a­tions are even steeper for for­eign in­vestors who bench­mark their yields in In­dia with bench­mark in­ter­est rates in the US. The earn­ings yield for the broader mar­ket is now down to a record low of 3.3 per cent and its spread over US trea­sury yields is at a record low of 0.93 per­cent­age point.

The spread was 1.9 per­cent­age point at the end of FY16 and 4.8 per­cent­age points at be­gin­ning of the cur­rent rally in March 2013. The spread was 1.5 per­cent­age point at the end of March 2008.

The earn­ings yield is the po­ten­tial yield for an eq­uity in­vestor if the com­pany pays 100 per cent of its cur­rent (an­nual) net profit as eq­uity div­i­dend. Sim­ply put, it is net profit di­vided by the mar­ket cap­i­tal­i­sa­tion of a com­pany. Typ­i­cally, the earn­ings yield on equities should be suf­fi­ciently higher than the yield on risk­free as­sets (such as gov­ern­ment bonds) to com­pen­sate for the greater risk of own­ing equities.

An­a­lysts say that this raises the prospect of an out­flow of cap­i­tal from the eq­uity mar­ket if the bond yields in the US har­den any fur­ther. “The mar­ket has been ex­pen­sive for too long now, aided by lower in­ter­est rates in ma­jor de­vel­oped mar­kets like the US. Any fur­ther tight­en­ing of in­ter­est rates in the US or fur­ther fall in the earn­ings yield in In­dia may lead to a mar­ket cor­rec­tion,” says Dhanan­jay Sinha, head re­search, econ­o­mist and eq­uity strate­gist, Emkay Global Fi­nan­cial Ser­vices.

The bench­mark in­ter­est rates in the US are up nearly 20 bps since the be­gin­ning of the cur­rent cal­en­dar year. One ba­sis point is one-hun­dredth of one per cent.

This has been partly com­pen­sated by around a de­cline of 10 bps in bench­mark in­ter­est rates in In­dia. While many are ex­pect­ing in­ter­est rate cuts by the Re­serve Bank of In­dia, there are oth­ers who think oth­er­wise. They ar­gue that in­ter­est rates in In­dia could rise, as var­i­ous state gov­ern­ments hit the bond mar­ket to raise funds to fi­nance the farm loan waivers and big­ger fis­cal deficits.

For do­mes­tic in­vestors, the yield spread on equities (dif­fer­ence be­tween 10-year G-Sec yield and equities yield) is now a neg­a­tive 3.2 per­cent­age point, which is worse than a neg­a­tive spread of 2.8 per­cent­age point at the end of March 2014 but bet­ter than neg­a­tive 4 per­cent­age point at the end of FY15.

Sim­ply, a broad port­fo­lio of stocks now yields a po­ten­tial div­i­dend of ~3,300 for ev­ery ~1 lakh worth of in­vest­ment, down from ~4,000 at the end of March 2016 and ~6,600 at the end of March 2013.

The mar­ket is set to get even more ex­pen­sive as bro­ker­ages ex­pect com­pa­nies to report de­clines in net prof­its on a yearon-year (YoY) ba­sis dur­ing the June 2017 quar­ter. The com­bined net profit of all Nifty50 com­pa­nies is ex­pected to de­cline by 2.6 per cent YoY dur­ing the quar­ter, while ex­clud­ing met­als & oil com­pa­nies, the net profit is likely to de­cline by 7.6 per cent YoY for the June quar­ter. Three in­dex com­pa­nies — TCS, In­dusInd Bank, and In­fosys — have re­ported their first-quar­ter re­sults so far and the net profit trend is far from be­ing ex­cit­ing.


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