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Photo: Mint

Stock valuations hit historic highs amid headwinds

The stock market has got back to rallying since late September. The current levels of the Nifty and Sensex are very close to the peak levels seen in the beginning of 2020. The Sensex has rallied 11% since 24 September. So, what is happening? Mint takes a look.

The stock market has got back to rallying since late September. The current levels of the Nifty and Sensex are very close to the peak levels seen in the beginning of 2020. The Sensex has rallied 11% since 24 September. So, what is happening? Mint takes a look.

Why are stock  markets rallying since Sep-end?

Foreign investors started coming back to the Indian capital market in October, after remaining net sellers in September. A bulk of returns have hence come in this month. Foreign institutional investors (FIIs) have bought stocks worth 3,990 crore in the month so far. On the flip side, domestic institutional investors (DIIs), such as the mutual funds, insurance companies, banks and the new pension system, have sold stocks worth 3,159 crore in October. Over the years, FIIs and DIIs have moved in opposing directions—when FIIs buy, DIIs sell, and vice versa. October 2020 was no different.

How does the FII, DII shift affect valuations?

All the domestic and foreign money that has flown into stocks during this fiscal year, has driven the price-to-earnings (PE) ratio of shares to astonishingly high, and never seen before levels. As on 12 October, the PE ratio of the Sensex shares stood at 29.6. This means that for every one rupee of earning for stocks that make up the benchmark index, the investors are ready to pay 29.6. And the euphoria doesn’t end here. When it comes to the Nifty, the PE ratio was at an even higher level of 34.8. Clearly, the investors who are bringing in fresh money into the markets are not bothered about such high PEs.

Piquing overseas
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Piquing overseas

Are these high stock valuations justified?

Such high PE ratios are historically unheard of and can’t be justified in terms of expected future earnings of companies, given that they are likely to remain subdued in a post-covid environment, where companies will find it difficult to keep growing their sales and profits. The high valuations are a reflection of the lack of other investment options.

What is driving people towards stocks?

This is primarily an effect of lack of better and lucrative options. The post-tax return on bank fixed deposits is currently much lower than the prevailing rate of inflation. Even for someone in the 10% tax bracket, post-tax return on a fixed deposit is likely to be

4.5-5%, when inflation as measured by the consumer price index is at 7.3%. This has pushed people towards investing in stocks despite the high valuations. It can be understood by the rapid growth in the number of demat accounts so far in 2020.

How has the growth in demat accounts been?

So far in 2020, 6 million demat accounts have been added taking the total number to 45.3 million, up 15% from December 2019. Stock brokerages have also reported an increase in activity of existing accounts. This is a clear reflection of the lack of other investment options. Many youngsters who have lost their jobs post-covid, have started looking at stocks as a way to make a quick buck, without requiring a large amount of capital.

Vivek Kaul is the author of Bad Money.

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