Will 2010 be like 2004, the beginning of another stock market boom? After all, earnings are forecast to rise by at least 20% in 2010-11—brokerage Motilal Oswal expects them to rise by 29%. In 2003-04 too the Sensex EPS (earnings per share) went up by 28%. Unfortunately, the valuations are already factoring in that kind of growth. The difference between 2004 and today is that while the one-year forward PE (price-earnings) multiple for the Sensex was 12.4 in March 2004, the PE (on 2010-11 earnings) is already above 16.
The chart shows the earnings of the Sensex firms from 1992-93 onwards. The data shows that between 1993 and 1996, EPS of the Sensex firms increased from Rs81 to Rs250, a rise of 208%. How much did the Sensex go up in these years? It rose from 2,280 points in March 1993 to 3,366 in March 1996, an increase of 47.6%. The rise in the Sensex was much lower than the rise in the Sensex EPS.
Also See Sensex movement (Graphics)
Now consider the period between 1995-96 and 2002-03. As the chart shows, Sensex EPS increased by a mere 8.8% over seven years. During this period, the Sensex actually fell by 9.4%. If we were to break up this period into two parts, one from 1995-96 to 1999-2000 and the other from 1999-2000 to 2002-03, during the first part the Sensex went up by 48.5%, although Sensex earnings rose by just 12%. During the second period, while Sensex earnings declined by 2.8%, Sensex went down by 39%.
During the boom of 2003-08, however, EPS of the Sensex firms rose from Rs272 to Rs718, an increase of 164%. The rise in the Sensex over this period, though, was much higher, with the benchmark index rising to 15,644 points at end-March 2008 from 3,048 in March 2003. That’s a rise of 413%. In short, during this boom, the rise in the Sensex was much higher than that warranted by the growth of the Sensex EPS.
What the numbers given above show is that growth in earnings is only one factor in the growth in stock prices. What then was the deciding factor? Liquidity. The expansion and contraction of the PE multiple, rather than growth in the Sensex earnings, was the major factor behind the rise or fall of Sensex. The chart shows the one-year forward PE multiple for the Sensex since 1993. The range has been a wide one, varying between 8.8 and 23.2.
What the Sensex needs to go up is ample liquidity. For the Indian markets, the source of that liquidity lies in portfolio inflows from the West. And while liquidity is expected to remain ample in early 2010, it will start getting slowly withdrawn during the year. Unfortunately, with the Sensex around 17,400 points and the 2010-11 Sensex EPS estimated at Rs1,060, the forward PE multiple for the Sensex works out to 16.4, near the top end of the range and higher than what it was in March 2007.
In short, we’re already at valuations that were reached at the fag end of the last boom. This time it’s very different from 2004.
Graphics by Yogesh Kumar / Mint
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