Mumbai: Amid rising uncertainty surrounding future corporate earnings in India, many equity analysts say that while P-E, or price-earnings, multiples may have become cheaper in the past six months as stock prices dropped, P-E may no longer be the best tool to spot bargains.
Most Asian markets, including India, are in a firm bear grip, slumping in the range of 13-40%, fuelled primarily by global macroeconomic headwinds.
(THE VALUATION GAME) As a result, some analysts say that PB, or price-to-book, is emerging as a more accurate tool to interpret valuations and sense the direction of markets.
P-E multiples are arrived at by dividing the current market price of a firm by its earnings. Since markets tend to price future events, analysts estimate P-E multiples on estimated future earnings. Typically, a high P-E can mean an overpriced stock but, it can also indicate good future prospects of a company. A low P-E may mean the stock is either undervalued or unattractive.
PB refers to the comparison of a firm’s market value to its book value, which in turn, is the net worth, or equity and free reserves of a company, calculated by subtracting liabilities and intangible assets, such as patents and goodwill, from total assets.
Garry Evans, Hong Kong-based strategist at Hong Kong and Shanghai Banking Corp. Ltd (HSBC), believes that while P-E multiples might look cheap, reliability of earnings forecasts is a growing problem as analysts’ consensus forecasts for earnings per share (EPS) growth in Asia, excluding Japan, have come down to 5.5% from 10.5% between January and now.
“Certainly, most markets in Asia have tended over the past 10 years to bounce off a fairly consistent PB level,” Evans pointed out in an equity strategy report released on Friday.
Sunil Garg, Hong Kong-based managing director and head of equity research for the region, of JP Morgan Securities (Asia Pacific) Ltd, also says it is more sensible to look at PB levels when earnings visibility is low.
However, the PB levels in 2000 cannot be compared with the current levels as “the economic conditions in Asian countries have changed dramatically,” he said adding that he continues to be “very bearish” on Indian equities.
According to the HSBC report, the current PB multiples of the Indian stock markets, stands at 3.2 times. The PB level, when the markets bottomed out during its previous bear phase in 2000, was 1.6 times.
If one goes by this valuation tool, Indian markets should fall another 93% from the current levels to hit the earlier PB levels, according to HSBC’s research, something that very few analysts expect.
The loss on India’s bellwether equity index Sensex this year now stands a tad below 30%. The Sensex gained more than 18% in just five trading sessions between 16 July and 23 July, participating in an Asia-wide rally, fuelled by declining crude prices. The Congress government’s win in a crucial trust vote, which has opened doors for the nuclear deal with the US and some much anticipated reforms, also contributed to the rally. However, it was followed by 667.34 points, or 4.47%, fall in the last two days.
The most recent rally was the third bear market rally since the beginning of this bear phase that started in January after the Sensex hit its high of 21,206.77. A sharp rebound, upward of 10%, in a falling market is typically dubbed as a bear rally.
The P-E multiple of the Sensex, which has 30 stocks, was 28.57% in January and has since come down to 17.74%.
A separate 25 July research report by HSBC on Indian economics and strategy, says that during the previous bear market in 2000-03, there were five such bear rallies of 10% or more, before the market bottomed out in 423 trading sessions.
During the bear market in 1998-99, there were four rallies of 10% or more, before the market bottomed out in 321 trading sessions.
Similarly, there were four bear rallies of more than 10% rise during the bear market in 1992-93, where the recovery was much faster, in 265 trading sessions.
The current bear market has so far lasted 142 trading sessions.
The Indian stock market’s valuations, in terms of PB multiples, is much higher than that of Chinese markets, currently trading at 2.9 times its book value.
However, the PB multiples of the Chinese markets, during its low in 2000, was 1.6 times. This means that for China’s markets to hit the bottom level in 2000, it has to correct some 170% from here.
India is the second most expensive market in Asia Pacific, after Indonesia, which currently trades at 3.7 times PB. The average of the current PB multiples of Asian markets excluding Japan, is about 2.1 times.
The Japanese market is currently trading at 1.5 times its book value, while its 2000-low is 1.2 times, which leaves room for another 26% correction to hit that level.
Similarly, other key Asian markets such as Hong Kong, South Korea and Taiwan, have to correct 56%, 90% and 43% respectively, to hit the valuations of their 2000 low.
Other important markets such as Singapore and Australia are now trading at 2.0 and 2.4 times their book value, respectively. Singapore’s lowest PB multiples in 2000 was 1.1, while that of Australia was 1.7 times.