Sensex may see modest correction in near term

Sensex may see modest correction in near term
Business Standard, September 9, 2009, Section II, Page 10

BG Shirsat / Mumbai

The index is trading at a P/E of over 19 times.

After trading in the range of 15,100-16,000 during the period between the middle of July and September 7, 2009, the BSE Sensex has finally crossed and closed above the upper band. Not only has the Sensex doubled from its multi-year lows (on March 9), even price to earnings (P/E) has jumped almost 100 per cent from 10.9 times in March to 19.44 times now. The Sensex has outperformed the world markets with only Hang Seng coming close to it with 74 per cent return. The markets in Europe, US and Japan are almost half way through the Sensex rise.

This V-shape rally is attributed to the stimulus packages and the clear mandate to the Congress-led United Progressive Alliance (UPA) in the last general elections. Analysts are expecting a modest correction as the Sensex is trading at a P/E of over 19 times, based on trailing 12 months profits ending June 2009. The one-year forward P/E is at around 17.6, based on earnings expectation of various Indian and foreign broking houses for the financial year 2010. The Sensex is currently trading at a P/E of 14.9 times of estimated earnings for the year 2011. The 15-year average P/E for the Sensex is around 15 times, so it is fully priced.

The net profit of the Sensex companies, based on research reports available in August 2009, is expected to grow by 10.5 per cent in nine months of the current financial year over the net profit earned during the trailing 12 months ended June 2009. The net profit is estimated to grow by 17.9 per cent in 2010-11. However, even at the forward profit for 2010 and 2011, as many as 20 stocks are currently trading above the estimated P/E for those two years. The cheapest stock based on forward earning could be Reliance Industries (RIL), which is trading at a P/E of 11 times of its estimated earnings for 2011.

Equity analysts expect automobile, banks, construction, capital goods, fast moving consumer goods (FMCG) and realty companies to show a modest growth in forward earnings. So, forward P/E ratio is likely to be above 20 times of their forward earnings. The forward P/E of Sensex stocks such as DLF, Tata Motors, Larsen & Toubro, JP Associates, Infosys Technologies and Wipro is over 20-30 times of their forward earnings. Comparatively, the cheaper stocks would be Tata Power, Sterlite Industries, Bharti Airtel, Tata Steel, Reliance Communication, Grasim and ACC.

A Credit Suisse report on the India market strategy expects the Sensex to correct to below 13,000 by January 2010, although the correction may only begin after the October results season. The report indicates that equity markets may come under pressure from inflation-related developments. The correction, however, should prove temporary, lasting only a few months, but investors planning to benefit from the correction should reduce beta by trimming bank, auto, capital goods and real estate stocks in their tactical or short-term portfolio, the report suggests.

An equity analyst at UBS expects fundamentals and liquidity to support higher valuations for the Indian market. Indian stocks are likely to re-rate further over the medium term as positive data points relating to IIP, GDP and quarterly earnings show a positive momentum. The analyst also expects 2010-2011 to fully capture the economic recovery and corporate earnings, thereby pushing the Sensex to around 20,000 by March 2011. He is overweight on steel, power, real estate and IT services sectors. Even Morgan Stanley has revised upward its Sensex target for June 2010 to 17,600 from 17,000. The key drivers for the market could be reforms and infrastructure spending. The Sensex constituents are likely to grow earnings at an annual compounded rate of 15 per cent on an aggregate basis. If growth turns out to be, say, 20 per cent, returns from the market will be significantly superior to what investors have earned over the past 10 years.