BackValuation drop is a silver lining to the market crash
While the P-E ratio has fallen during the course of this month, it is still higher than the average ratio of 19.3 since April 1998, for which data is publicly available.
PremiumIndian stocks have been richly valued for a while now and their prices have gone up from 2012-2013 onwards, without a commensurate rise in company earnings. The recent stock market crash has reduced overvaluation concerns to some extent. Mint takes a detailed look.
What’s been the price-earnings ratio in FY20?
The price-earnings ratio of Sensex stocks in 2019-20 has been 26.89. This means, on an average, investors were willing to pay ₹26.89 to receive ₹1 of earnings from stocks that comprise the benchmark Sensex index. As can be seen from Chart 1, the price-earnings (P-E) ratio in 2019-20 has been the highest in more than two decades. It has gone up in each of the fiscals from 2012-13 onwards, when it was 17.09. This basically means that stock prices have gone up at a much faster rate than company earnings, thereby pushing up the numerator at a much faster rate than the denominator.
What factors have driven up the ratio?
Too much money has been chasing stocks. Between 2012-13 and 2019-20, foreign institutional investors have net invested ₹4.42 trillion in Indian stocks. A bulk of this investment took place between 2012-13 and 2014-15. This was mainly due to easy money floating around in the Western world as central banks printed a lot of money in the aftermath of the 2008 financial crisis. Domestic institutional investors (DIIs) have net invested ₹3.16 trillion since November 2016, the month the note ban was announced. This has driven the market over the last few years. DIIs invest money they collect from retail investors.
Why have retail investors poured money into stocks?
Post the note ban, interest rates on fixed deposits fell. Real estate has been down in the dumps for over half a decade now. Gold prices have rallied only in the last one year. This did not leave the retail investor with much of an option but to invest money in stocks. The fact that stock markets have gone up over the last four years has attracted more retail money into stocks.
What’s the situation now on the P-E front?
Take a look at Chart 2, which basically plots the P-E ratio of Sensex stocks over the last one year. The ratio peaked at 29.18 on 19 December and 20 December 2019. On 13 March 2020, the ratio was 20.82, its second-lowest level in the current fiscal. The lowest was 19.78 a day earlier. The fall in stock prices has been triggered by fears over the spread of the Covid-19 disease and the impact it is likely to have on economic growth. The good part is that valuations are getting more attractive in the process.
How does the P-E ratio compare historically?
While the P-E ratio has fallen during the course of this month, it is still higher than the average ratio of 19.3 since April 1998, for which data is publicly available. Also, this ratio considers only past earnings of companies. Earnings of companies are likely to fall even further during the March and June quarters due to the self-isolation being recommended and practised in order to prevent the spread of the coronavirus. That’s clearly not good news.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
