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Business News/ Markets / Stock Markets/  104 companies with above 50x PE, 9 with above 100x: Kotak warns of high P/E multiples in Indian equity market
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104 companies with above 50x PE, 9 with above 100x: Kotak warns of high P/E multiples in Indian equity market

Kotak Institutional Equities warns of high P/E multiples in Indian equity market, with 104 companies trading above 50X P/E and 9 above 100X P/E.

Kotak Institutional Equities warns of high P/E multiples in Indian equity market, with 104 companies trading above 50X P/E and 9 above 100X P/E. Premium
Kotak Institutional Equities warns of high P/E multiples in Indian equity market, with 104 companies trading above 50X P/E and 9 above 100X P/E.

The Indian equity market appears to be exhibiting a sense of benevolence or complacency, as fundamental issues like market size and profitability are being sidelined in favor of an obsession with growth narratives, observed Kotak Institutional Equities. In the current scenario, it pointed out that valuation methodologies have low or no linkage to fundamentals, which makes high multiples palatable, no matter how outrageous the implied math for underlying parameters becomes at higher multiples.

Currently, 104 companies are trading at above 50X P/E (one-year forward consensus) in the Indian market while 9 companies trade above 100x P/E. The brokerage noted that a 100x P/E company should have 83,000 times earnings in the 100th year to justify its current multiple if earnings were to compound at the cost of equity of 12 earnings. Furthermore, a 100X P/E should grow its earnings at 20 percent over 20 years and lower its growth rate after that to justify its multiple in a hypothetical higher-growth scenario, it added.

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"The benevolence and/or complacency of market participants have resulted in a large number of stocks trading at astronomically high levels. Investors may want to get a handle on the market size implied by such high multiples.

A 100X P/E essentially implies earnings growing at the rate of cost of equity over 100 years or at much higher growth rates over a shorter period of time," cautioned Kotak.

This mood has resulted in a much higher number of high P/E companies currently compared with history, it revealed.

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The image below shows the number of Indian stocks that have been trading above 50X and 100X each year in the past decade on a one-year forward basis.

Source: Kotak
View Full Image
Source: Kotak

Even when ignoring ‘young’ companies in ‘young’ industries, the number is very high. It is interesting to see that several such high P/E companies are in ‘traditional’ sectors, which face massive disruption risks, stated the brokerage.

100X P/E = 83,000X earnings in the 100th year

Kotak explained that a simple but stark way to appreciate a P/E multiple is that the P/E multiple is the number of years a company will have to grow its earnings at the current cost of equity (ignoring terminal value). Thus, a stock trading at 100X P/E would theoretically need to compound its earnings (FCFE) at the rate of cost of equity over 100 years. Thus, such a company will need to deliver 10,000X-83,000X current earnings in the 100th year, depending on the cost of equity. Ceteris paribus, the sector will need to expand by a similar quantum.

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Another key point, as per the brokerage, is that 100X P/E requires higher earnings CAGR for shorter growth phases.

"Companies will require sharper and higher growth rates over a shorter period to justify very high P/Es. A 100X P/E company, which may be in the growth phase over the next 40 years, will need to report an earnings CAGR of 20 percent over the next 20 years and a 9 percent CAGR over the subsequent 20, according to our simplistic DCF model. If the industry’s growth phase were to be shortened by 20 years, the required growth rates would be even higher. Even if we assume (1) stable market structure and (2) stable profitability, the particular sector will then require becoming 200X in the first scenario and 30X in the second one. Only a few sunrise sectors may pass this small test!," decoded the brokerage.

The brokerage further noted that many sectors and stocks enjoy very high profitability and returns, which are unlikely to last beyond the next 5-10 years, as forces of disruption have strengthened across sectors. The implied market size would need to be even higher in case profitability were to decline from current elevated levels. The latter is extremely likely, the former is unlikely, it said.

Source: Kotak
View Full Image
Source: Kotak

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.

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Published: 21 May 2024, 12:12 PM IST
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