Valuations still not low enough?

Valuations still not low enough?
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First Published: Fri, Feb 22 2008. 11 25 PM IST

Updated: Fri, Feb 22 2008. 11 25 PM IST
High valuations seem to be taking a toll on the Indian market.
The Indian market has been one of the worst performers this year, with the Morgan Stanley Capital International (MSCI) India index down 15.9% year to date as on 21 February, while the MSCI Emerging Markets index is down just 7.3%. Moreover, most emerging markets have seen a smart bounce this month, with the result that the MSCI Emerging Markets index is up 6.1% (as on 21 February) compared with a decline of 1.8% in the index for India in February. In fact, India is one of the very few emerging markets that is not in positive territory this month.
What could be the reason? A recent research note from Goldman Sachs Group Inc. says that the Indian market’s valuation is still too high and it trades at a 50% premium to the region on the basis of forward price-earnings (PE) multiple.
More significantly, Goldman Sachs believes that “India’s pricing implies an expectation of 18% EPS (earnings per share) compound annual growth compared with mid-single digits for most other markets and 13% for China.” Interestingly, current consensus estimates are for a re-acceleration of earnings growth of above 20% in fiscal 2010.
The consensus price-earnings multiple for MSCI India is around 19, which makes it important that growth continues to be high. Except for utilities and materials, most other sectors still assume growth higher than their PE multiples. Jeff Hochman, director of Technical Research at Fidelity International, London, has in a recent note argued that India’s PE to growth ratio is at 1.39, the same as the world average. China’s is 1.03, Japan’s 1.79, but the most overvalued market is the US, which has a PE to growth ratio of 5.12, according to Hochman. Data such as this was behind the now-unloved view that money would flee the distressed credit markets of the West for emerging Asia’s more salubrious climes.
Independent research outfit BCA Research Inc. says “there is a mountain of US investable cash sitting on the sidelines, earning an ever-dwindling rate of interest.” When and where will this cash get deployed? While it’s unlikely that the markets will go up before light is seen at the end of the credit market tunnel, the cash mountain will ensure that risky assets go up very sharply once the fear ends.
Current correction sharper than in May 2006
The recent correction in the Bombay Stock Exchange’s Sensex seems less destructive than the one in May-June 2006 when the index had dropped by 30% at one point. But a greater percentage of shares have fallen and overall market value has declined by a slightly higher amount this time around, data collated by Capitaline Plus shows.
The above calculation is based on the change between the intra-day highs and lows of all traded scrips during the past two months compared with the trend in May and June 2006. In the recent correction, overall market value of 2,969 stocks has declined by 42% based on the intra-day low, when compared with the intra-day high of each scrip.
In May 2006, overall market value of 2,582 stocks had fallen 41%. In addition, nearly 45% of the stocks fell by more than 50% at some point in this correction, higher than the proportion (42%) back in 2006. The difference between the highs and lows during the period indicate the buying opportunities that came up during the past two months. A break-up of the data based on market capitalization shows that large corrections happened across various segments.
Companies with a market cap of over Rs25,000 crore at their peak lost 40% in value cumulatively, and so did stocks with a market cap of between Rs10,000 crore and Rs25,000 crore. Stocks with a market cap of less than Rs10,000 crore lost 45% in value, a tad higher. But based on current market prices, small- and mid-cap stocks have lost much more compared with their highs, which essentially means that they have recovered to a lesser degree from their lows.
With the global uncertainty and liquidity constraints, investors seem to be clear about their preferences: good quality, large-cap stocks.
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First Published: Fri, Feb 22 2008. 11 25 PM IST