Though Sensex has been Correcting itself Since Last November, at Current PE, it looks Overvalued. And with Jittery Corporate profit growth Forecasts, it is surely due for Further Correction.
24.15 was the PE multiple (price to earnings) of Sensex when the BSE benchmark scaled its lifetime high of 21,005 for a day in November last year. At the same time, that was the value which made many analysts act like disciples of Yale professor Robert Shiller calling the market movements “irrational exuberance” (Author of Irrational Exuberance Shiller, using Cyclically Adjusted PE model, had claimed at the peak of dotcom bubble that markets are overvalued and soon it succumbed to the bubble burst bringing glory to the author). And as we know since then, the Sensex has rolled down 12.21% to close at 18,439 on March 14, 2011. But the million dollar question that still worries a common investor is that, with the Sensex PE reading 20.02 currently – against 10-year average (quarterly) of 18 – can we say that the index is operating at a sustainable value or is it just a breather before another major correction?
Before getting into the details one first needs to understand what does PE multiple of an index stand for? In simple words, Sensex PE at 20 means Sensex is now valued at 20 times the cumulative earning power of its 30 constituents. Even if it sounds arbitrarily high for a common investor, in true terms, it is nothing new for the Sensex, more so for that the index has sustained over this value for over 18 months between 2006 and 2008. So, what is the problem that we are talking about?
Well, it’s actually the change in conditions, both economic and market. The most critical fact about the PE multiple of Sensex is that it is based on the anticipated earning power of the companies and while the economic conditions were suitable in 2006-07 to achieve rapid growth, it’s bleak at present. Although the reviving demand, both in the domestic market and globally, will provide Indian companies a boost in sales, the real task is to maintain the kind of profit margin that they are used to. If a substantial rise in raw material prices in the last year was not enough to dampen the momentum, rising crude oil price (already gone past $100 per barrel) is ensuring that the corporate profit in the coming months falls below market expectations. And the trend is already setting in. Considering the quarter-on-quarter cumulative net profit of Sensex companies in 2010, the growth quotient has fallen from 15.41% in the March quarter to 8.45% in December, threatening the market confidence and of course, the future value of the index.
In fact, discounting for the negative sentiments, the Sensex, which offered a mind boggling 157% between March 2009 and November 2010, has already lost over 12% since then. Whereas, global indices like Dow Jones Industrial Average and S&P 500 have advanced 4.3% and 6.3% respectively during the same period. For that matter, despite being on the receiving end, other BRIC benchmark indices have confined their losses to 6 to 8%. In fact, the Russian RTS index has gained a mind-boggling 18.5% during the same period.
24.15 was the PE multiple (price to earnings) of Sensex when the BSE benchmark scaled its lifetime high of 21,005 for a day in November last year. At the same time, that was the value which made many analysts act like disciples of Yale professor Robert Shiller calling the market movements “irrational exuberance” (Author of Irrational Exuberance Shiller, using Cyclically Adjusted PE model, had claimed at the peak of dotcom bubble that markets are overvalued and soon it succumbed to the bubble burst bringing glory to the author). And as we know since then, the Sensex has rolled down 12.21% to close at 18,439 on March 14, 2011. But the million dollar question that still worries a common investor is that, with the Sensex PE reading 20.02 currently – against 10-year average (quarterly) of 18 – can we say that the index is operating at a sustainable value or is it just a breather before another major correction?
Before getting into the details one first needs to understand what does PE multiple of an index stand for? In simple words, Sensex PE at 20 means Sensex is now valued at 20 times the cumulative earning power of its 30 constituents. Even if it sounds arbitrarily high for a common investor, in true terms, it is nothing new for the Sensex, more so for that the index has sustained over this value for over 18 months between 2006 and 2008. So, what is the problem that we are talking about?
Well, it’s actually the change in conditions, both economic and market. The most critical fact about the PE multiple of Sensex is that it is based on the anticipated earning power of the companies and while the economic conditions were suitable in 2006-07 to achieve rapid growth, it’s bleak at present. Although the reviving demand, both in the domestic market and globally, will provide Indian companies a boost in sales, the real task is to maintain the kind of profit margin that they are used to. If a substantial rise in raw material prices in the last year was not enough to dampen the momentum, rising crude oil price (already gone past $100 per barrel) is ensuring that the corporate profit in the coming months falls below market expectations. And the trend is already setting in. Considering the quarter-on-quarter cumulative net profit of Sensex companies in 2010, the growth quotient has fallen from 15.41% in the March quarter to 8.45% in December, threatening the market confidence and of course, the future value of the index.
In fact, discounting for the negative sentiments, the Sensex, which offered a mind boggling 157% between March 2009 and November 2010, has already lost over 12% since then. Whereas, global indices like Dow Jones Industrial Average and S&P 500 have advanced 4.3% and 6.3% respectively during the same period. For that matter, despite being on the receiving end, other BRIC benchmark indices have confined their losses to 6 to 8%. In fact, the Russian RTS index has gained a mind-boggling 18.5% during the same period.
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
For More IIPM Info, Visit below mentioned IIPM articles
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
For More IIPM Info, Visit below mentioned IIPM articles
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Ranked 6th Overall
Zee Business Best B-School Survey 2012
Prof. Arindam Chaudhuri’s Session at IMA Indore
IIPM IN FINANCIAL TIMES, UK. FEATURE OF THE WEEK
IIPM strong hold on Placement : 10000 Students Placed in last 5 year
IIPM’s Management Consulting Arm-Planman Consulting
Professor Arindam Chaudhuri – A Man For The Society….
IIPM: Indian Institute of Planning and Management
IIPM makes business education truly global
Management Guru Arindam Chaudhuri
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IIPM B-School Facebook Page
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