There's been quite a lot of material written on how investors should be cautious given the run up in stocks in the recent past; we ourselves have written about the same. A favourable outcome of the ongoing elections has been the key reason for the market run up in the past few months. With such expectations, investors - both foreign and local - have increased their participation in the Indian equity markets in hopes of not missing out on any market rally.
With this background in mind, we thought it would be a good idea to do some basic level digging and check whether the same holds true; i.e. gauge the impact of the run up in stocks as opposed to the change in fundamentals.
Sensex Marches on Despite Earnings Growth Slowing Down
A quick glance at this chart indicates that the Sensex has run up in recent times, despite the earnings growth rate slowing down.
But then, you would think, does this comparison make sense without looking at valuations?
This led us to generate the following chart:
But... when it comes to valuations, things do not seem all that bad
The slowdown in the earnings growth seems to have been reflected in the lower valuations as well. At least in the past few years; since 3QFY11, if one goes purely by the chart. The current valuations of the index are also lower than what they have been in the decade gone by.
However, having seen this, you would probably make the case for the Sensex usually reflecting future earnings. Which is why gauging the one year forward P/E Ratio would make sense!
Okay sure...
The following chart depicts the same...
Sensex: 1-Yr Forward P/E Ratio (assuming 10% growth in earnings)
We have generated the above chart by dividing the Sensex value at the end of each quarter by the trailing twelve month EPS of the corresponding quarter one year ahead. At the current juncture, the Sensex is seemingly trading at 16.7 times its estimated one-year forward EPS, which is equal to its long term average. And guess what, this is when considering a modest growth rate of 10% in EPS.
We must confess that before starting this procedure, we thought the results would be quite the opposite, i.e. the market run up in recent periods would have actually seemed euphoric. But that does not seem to be the case, at least going by the data provided above. What the data indicates is that now is as good a time as any to invest in stocks from a long term perspective. An investor can be assured of reasonably good returns.
Nevertheless, given that the Sensex is a collection of many stocks, it goes without saying that taking an individual stock approach to investing would make sense. With a lot of uncertainty over how the economy will shape up a year from now, with the new government about to come in, sticking with companies that that are likely to post good growth figures would be essential. While there may be certain pockets of the market - such as the defensives - that offer such a feature, the key aspect to be remembered here would be not to overpay for such stocks; as the valuations could be driven by sentiments.
Whatever may be the outcome of the elections, the probability that stocks will remain volatile in the short term is quite high. Whichever direction the markets move, do remember that in the long run, the fundamentals tend to determine the movement in stock prices.
With this background in mind, we thought it would be a good idea to do some basic level digging and check whether the same holds true; i.e. gauge the impact of the run up in stocks as opposed to the change in fundamentals.
 |
A quick glance at this chart indicates that the Sensex has run up in recent times, despite the earnings growth rate slowing down.
But then, you would think, does this comparison make sense without looking at valuations?
This led us to generate the following chart:
 |
The slowdown in the earnings growth seems to have been reflected in the lower valuations as well. At least in the past few years; since 3QFY11, if one goes purely by the chart. The current valuations of the index are also lower than what they have been in the decade gone by.
However, having seen this, you would probably make the case for the Sensex usually reflecting future earnings. Which is why gauging the one year forward P/E Ratio would make sense!
Okay sure...
The following chart depicts the same...
 |
We have generated the above chart by dividing the Sensex value at the end of each quarter by the trailing twelve month EPS of the corresponding quarter one year ahead. At the current juncture, the Sensex is seemingly trading at 16.7 times its estimated one-year forward EPS, which is equal to its long term average. And guess what, this is when considering a modest growth rate of 10% in EPS.
We must confess that before starting this procedure, we thought the results would be quite the opposite, i.e. the market run up in recent periods would have actually seemed euphoric. But that does not seem to be the case, at least going by the data provided above. What the data indicates is that now is as good a time as any to invest in stocks from a long term perspective. An investor can be assured of reasonably good returns.
Nevertheless, given that the Sensex is a collection of many stocks, it goes without saying that taking an individual stock approach to investing would make sense. With a lot of uncertainty over how the economy will shape up a year from now, with the new government about to come in, sticking with companies that that are likely to post good growth figures would be essential. While there may be certain pockets of the market - such as the defensives - that offer such a feature, the key aspect to be remembered here would be not to overpay for such stocks; as the valuations could be driven by sentiments.
Whatever may be the outcome of the elections, the probability that stocks will remain volatile in the short term is quite high. Whichever direction the markets move, do remember that in the long run, the fundamentals tend to determine the movement in stock prices.
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