Indian equity markets seem to have brushed aside global economic recession and adverse macroeconomic factors on home ground such as high interest rates and inflation, which have made for anaemic corporate growth during the calendar year. The renewed optimism in our equity markets is displayed by the run-up in valuations, as seen in the price-to-earnings multiple (P-E) over the past 52 weeks.
Data on the indices and P-E ratios taken on 26 December for each of the past 10 years shows that the benchmark Sensex index’s average past P-E is at 17.3, higher than 16.4 last year on the same date. During the period, the Sensex moved up by around 24.4%. Data and analysts’ consensus view is that the run-up in valuations is mainly due to huge foreign fund inflows into Indian equity markets.
Two reasons explain this: a belief that the worst is over in terms of economic hurdles and the relatively higher depth and potential for growth in corporate earnings from these levels compared with most other economies.
In fact, valuations have run-up ahead of corporate earnings momentum.
That said, the jump in BSE’s mid-cap and small-cap indices’ past P-E compared with the year before is far more. This is perhaps because of higher volatility in the mid-cap and small-cap stocks. Note that on 26 December 2008, when the Sensex’s trailing P-E was at 12.4, the mid-cap and small-cap indices’ trailing P-E on BSE were at 8.5 and 6.3, respectively.
The hope is that corporate earnings growth rates will improve with lower inflation and interest rates, which would work in favour of valuations, driving them up further as hope turns into reality.
The Sensex’s past P-E is still below the 10-year average of 19.7, although it is significantly higher than the 10-year low of 12.4 touched in 2008.