The general elections are arguably the most important political event in any country. And with the same a few months away in India, it would definitely have its implications in terms of influencing stock price movement in the short term. As and when more news and developments take place, the volatility is bound to increase. Especially, considering that a good portion of the investors have placed long term bets on India from a perspective of their preferred political party coming into power.
While the outcome of the elections may see some major market swings, over the long term, it would be the earnings and valuations that would drive the movement in stocks.
Let's take the example of the benchmark index - the BSE-Sensex - for instance. At yesterday's closing price, the index was trading at a P/E ratio of 17.25 times its trailing twelve month earnings. Dividing the Sensex value by the same, we get the earnings per share (EPS) value about Rs 1,230.
Now, if one compares these data points over the longer term period, it does give an interesting picture.
Let's take the earnings growth rates first. Over a 10-year period, the earnings of the bluest of blue chips in India grew at a compounded pace of about 15% YoY. But when seen from a relatively shorter term period, the scenario is a bit different. Over a five, three and one year period, growth rates have deteriorated gradually. The five-year compounded annual growth rate (CAGR) in EPS stood at about 11.6%, while the same for the three-year period stood at 10.2%. However, in the last year i.e. on a YoY basis, the growth stood at 10.7%, which is slightly higher than the growth seen in the three year period.
Now, let us look at valuations. The average P/E over a 10-year period stood at 18.7 (it would be the same if we remove the extreme 10% outliers as well). Over the past five, three and one-year periods, the average valuations stood at 18.9 times, 17.78, times and 17.3 times respectively; indicating that the valuations have been coming down. Now, with the earnings growth rates slowing down, markets have pulled down valuations a bit we reckon.
But what is the way ahead from here?
We would like to clarify that we are not trying to predict the market levels, but are trying to gauge the market drivers going forward.
We believe that since the markets are trading at a discount to its long term valuations, given the relatively slower growth in recent earnings, a certain discount is being priced, thereby making the current valuations fair (discount of about 8%). This makes the growth rate in earnings the key driver of the value of the benchmark index.
We thought it would be a good idea to draw out various scenarios as to show how various earning growth rates and sentiments could drive the Sensex.
Data Source - Ace Equity
As the above table would indicate, at current valuations, the movement in the index would largely be driven by earnings growth levels. And what would drive the latter? Well, it would be a mix of factors, not limited to the consumption and investment patterns of the country.
But, it would not be wrong in saying that even at 8% growth rates, the index looks unlikely to fall below 20k even if one considers lower than historical average multiples. In other words such a scenario would only be possible when earnings growth rates deteriorate to closer to 8% mark - which seems unlikely given the long term trend - and also when valuations move closer to the 15 times mark - thereby making stocks cheaper as compared to the long term average, and therefore attractive.
While the outcome of the elections may see some major market swings, over the long term, it would be the earnings and valuations that would drive the movement in stocks.
Let's take the example of the benchmark index - the BSE-Sensex - for instance. At yesterday's closing price, the index was trading at a P/E ratio of 17.25 times its trailing twelve month earnings. Dividing the Sensex value by the same, we get the earnings per share (EPS) value about Rs 1,230.
Now, if one compares these data points over the longer term period, it does give an interesting picture.
Let's take the earnings growth rates first. Over a 10-year period, the earnings of the bluest of blue chips in India grew at a compounded pace of about 15% YoY. But when seen from a relatively shorter term period, the scenario is a bit different. Over a five, three and one year period, growth rates have deteriorated gradually. The five-year compounded annual growth rate (CAGR) in EPS stood at about 11.6%, while the same for the three-year period stood at 10.2%. However, in the last year i.e. on a YoY basis, the growth stood at 10.7%, which is slightly higher than the growth seen in the three year period.
Now, let us look at valuations. The average P/E over a 10-year period stood at 18.7 (it would be the same if we remove the extreme 10% outliers as well). Over the past five, three and one-year periods, the average valuations stood at 18.9 times, 17.78, times and 17.3 times respectively; indicating that the valuations have been coming down. Now, with the earnings growth rates slowing down, markets have pulled down valuations a bit we reckon.
But what is the way ahead from here?
We would like to clarify that we are not trying to predict the market levels, but are trying to gauge the market drivers going forward.
We believe that since the markets are trading at a discount to its long term valuations, given the relatively slower growth in recent earnings, a certain discount is being priced, thereby making the current valuations fair (discount of about 8%). This makes the growth rate in earnings the key driver of the value of the benchmark index.
We thought it would be a good idea to draw out various scenarios as to show how various earning growth rates and sentiments could drive the Sensex.
As the above table would indicate, at current valuations, the movement in the index would largely be driven by earnings growth levels. And what would drive the latter? Well, it would be a mix of factors, not limited to the consumption and investment patterns of the country.
But, it would not be wrong in saying that even at 8% growth rates, the index looks unlikely to fall below 20k even if one considers lower than historical average multiples. In other words such a scenario would only be possible when earnings growth rates deteriorate to closer to 8% mark - which seems unlikely given the long term trend - and also when valuations move closer to the 15 times mark - thereby making stocks cheaper as compared to the long term average, and therefore attractive.
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