Nifty at 9,000: the gap between earnings, valuations
Indian markets are trading at premium valuation multiples on expectations of a recovery in earnings and monetary easing. Is it time to be cautious?
The CNX Nifty index of the National Stock Exchange touched a record high on Tuesday, continuing to rally after the budget. In general, brokerages have remained gung-ho on the markets, citing that the budget was a step in the right direction. Sentiment has been upbeat for a while now. Since the beginning of January, the Nifty is up 8.61%, seemingly oblivious to the continuing earnings downgrades that happened in the December quarter.
Is it time to be cautious? Indian markets are trading at premium valuation multiples on expectations of a recovery in earnings and monetary easing.
The valuations of the Indian market are full, even after factoring in strong earnings growth over 2016-17, Kotak Institutional Equities Research said in a note dated 28 February. Valuations of high-growth and high-quality stocks have reached bubble levels even after assuming 50-200% increase in earnings per share over the next two years in several cases, it said.
“We are definitely at the higher end and it does look like the market is expensive," said Dhananjay Sinha, head of research, Emkay Global Financial Services Ltd. “On a one-year forward basis, Nifty is trading at about 21 times, the same level that existed in 2007 as well."
Some stocks such as Siemens Ltd, ABB India Ltd, Page Industries Ltd and Asian Paints Ltd are trading in range of 100-55 times their estimated earnings for the current fiscal year (see chart). Hopes of a steep recovery in the investment cycle have meant investors are willing to reward quality stocks. What is worrying, though, is that some of these stocks have run up even without earnings support.
The consensus is that it will take at least three to four quarters for investments to take off. “There are issues to resolve. It takes time to fix labour policies, land policies, making approval processes simpler and transparent, and ensuring resources for projects," said Sanjeev Prasad, senior executive director and co-head institutional equities at Kotak Institutional Equities.
Given the situation, it is strong global liquidity and softer crude oil prices that offer the much needed support to high valuations. That may be the reason why markets ignored the earnings disappointments in the last quarter. However, the big risk that the Indian equity markets face at present is what will happen in case of future disappointments.
As Saurabh Mukherjea, chief executive officer, Institutional Equities, Ambit Capital points out, the issue is not whether markets are expensive or not. “The main issue will be around how investors will deal with the weakness in March quarter earnings. I think we are heading towards a pull back on earnings. My sense is that the current optimism is a precursor to the profit booking that is expected," said Mukherjea.
Prasad of Kotak Institutional Equities agrees. “There is a huge gap between market valuations and earnings, and if the earnings do not catch up, it will be a big worry for the market," he said.
What offers a glimmer of hope is the fact that the world is flush with liquidity. Central banks in Europe and Japan are likely to pursue quantitative easing programmes for some more time to come even if the US Federal Reserve increases interest rates in the second half of 2015. “Thus, this factor may continue to support valuations at historically high levels until the global interest rate cycle turns unambiguously," said the Kotak report.
The writer doesn’t own shares in the above-mentioned companies.
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