Valuation questions.

What every Indian investor needs to ask…

After touching a peak of 9122 in March 2015, the Nifty has drifted in a range of 1000 points. Typically, any move closer to the 8000 level has attracted buying support and any move closer to the 9000 mark has attracted selling. It is time to ask a pertinent question. Are current valuations for Indian markets justified? Or are we thriving on hope?

P/E is rarely wrong

Despite all its shortcomings, the historical P/E rarely gets it wrong. It is good to talk about future earnings and value companies based on that. But the proof of the pudding lies in its eating. Over the last 3 quarters, most projections of company earnings have got it wrong. Frankly, you cannot say that earnings missed estimates, when in reality it is estimates that have failed to reflect earnings. So let us focus on historical earnings.

On a rolling P/E basis, the Nifty is quoting at around 22-23 times trailing earnings. That is slightly lower than the 26 P/E touched in 2008 and the 24 P/E touched in 2010. Technically, the current P/E may be lower but there is a difference. Both 2008 and 2010 represented an era of growing earnings. Today, earnings have been negative for 3 consecutive quarters. Obviously, the margin of safety at current valuations may not be too great. While it may not be right to say that valuations are steep, margin of safety is surely limited.
Macros are discouraging

A combination of domestic and global macros is conspiring to make current market valuations look rich. Let me illustrate a few of them. First and foremost, there is the big risk of a US Fed rate hike. It looks more likely the Fed will hike rates in September, resulting in liquidity outflows. This will also raise the base yields for markets making it more expensive at current levels. Secondly, domestic macros have hardly been supportive. Exports and imports have been falling consistently month after month, a typical case of India feeling the pinch of a global slowdown. Inflation is in negative territory and it is hard to decide whether it is low inflation or disinflation. A weak China means weak demand and a weak Europe means global turmoil. Neither is a positive for India.

Summing it all up

The moral of the story is that investors need to start asking themselves serious valuation questions. Both components of P/E; earnings growth and discounting are looking too hot to handle. Investors have three choices in front of them. They can be very stock specific and focus only on stocks with visibility. They can hedge their long positions for downside risk. Alternatively, they can adopt a passive approach to systematic allocation to equities. But, it is high time investors raise the V question! ©

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

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