Mumbai: Market analysts are happy with the recent performance of the Sensex and the Nifty indices. Although the markets are trading above mean valuations of 15-16 times past earnings, Raamdeo Agrawal, director and co-founder, Motilal Oswal Securities Ltd, said in an interview that he would be worried if shares trade at 25 times of earnings. Edited excerpts:
Optimistic: Raamdeo Agrawal, director, Motilal Oswal Securities Ltd.
Would you have predicted 17,500 points for the Sensex for 2009 as a closing basis?
We had given a range of about 17,000-17,500 and it’s literally coming to that kind of level. The expectation was that 2009 will be a good year because it started very badly.
Where do we go from here? Given large-cap and mid-cap valuations, what you are telling your clients now?
We have seen the worst just 15 months back. It is unlikely that you are going to see that bad situation in the near-term. I think we are into the next round of corporate profits boom.
My sense is that if we are able to do 7-7.5-8% kind of gross domestic product (GDP) growth rate from here, we are going to see a reasonably good growth in corporate profit. This year, we are saying more like 25% because there was profit growth holiday for 1-1.5 year.
Now that stock prices have moved up, people are projecting good numbers for 2011. Do you think those numbers will come through?
I think earnings will come through because there was a correction between 2008 and 2010... In some of the sectors that are completely bombed out, such as commodities, automotive and real estate, I think things can’t become worse. They will definitely come back. Corporates have also learnt out of the exercise they committed in the last business cycle. So, I do not see any problem in corporate profit building up. At 17-18 PE multiple (price to earning multiple, a measure of how expensive a stock is), I would think that market is expecting anywhere between 15-17% growth in corporate profits in the years to come. But if somebody starts expecting 25-30% growth rate, then we are into trouble zone.
Demand seems to have improved. When do we see the next leg of earnings and revenue growth being fuelled by growth in capital expenditure (capex)?
Some businesses are suffering from excess capacity. Hence, you will not see build-up of capex in those industries. However, if government gives permission, then there are a whole lot of guys waiting to put up steel plants. So the capex cycle can start there immediately.
There is a conducive environment for the projects to get off if the government can help them in getting land. There is some excess capacity in cement. The fresh commitment for capital cycle will happen maybe after 1.5-2 years once the capacity is absorbed... In the business cycle, like in consumer goods and automotive, we are going to see massive capex right now because most companies are not able to supply the demand in the market place.
Interest rates will also start heading up sometime in 2010. What do you think is the lower end of the PE band that the market might trade in?
I have seen in the last five-six years that the corporate profits and GDP keeps growing, but market builds up to 25-30 PE multiple and comes back all the way to 10-12 PE multiple. Like in 2002-03, it was 10 PE multiple and in 2009, we came down to below 8,000 Sensex—we again came down to 10-11 PE multiple. So market has this tendency of building up and then giving up all the re-rating. It de-rates just in 12-18 months. So that’s a painful thing, which one wants to avoid. But it is very difficult to predict when it’s going to happen; it may happen next year also.
But typically it doesn’t happen from a mean level of 15-16 PE multiple. In last 15-20 years the mean levels of market valuation is about 15-16 times. So we are closer to the mean, slightly above the mean and even if it corrects to the mean, which is about 10%, I do not (say) that’s unhealthy.