Indian Market Valuation

Whoa!!!! As if there is no tomorrow, as if the new government has a magic wand to rectify all that is not working. That is what current Sensex and Nifty levels tell me.

I took a break to concentrate on my CFA Level 2 exam and indeed it was a pleasant break - with Indian markets delivering their best ever monthly returns. Like many, I am also trying to find reasons that could justify such a rise. Plenty of reasons have been floating around including the possibility of material reforms, India playing catch up with other BRIC nations.

But the truth is that markets have been largely driven by a change in sentiment due to lot of hopes. Now that is something to be cautious about. Given the high level of expectations, any failure to meet them will result in disappointment and sell off. FII’s have been fueling the rally and invested more than 4 Billion dollars in the month of May. Now that figure is quite staggering considering that highest ever inflow for an entire year in the Indian markets have been around 13 billion dollars.

The question however is whether these levels are sustainable or not? Are the Indian Markets fairly valued, under-valued or over-valued? Investing is as much about facts as it is about hopes and opinion. A look at the most simple metrics – P/E and P/B exhibits and to some extent explains the current uptrend and its sustainability.

Sensex Historical Valuation
Year	P/E	P/B
1992 – 93	36.25	6.32
1993 – 94	36.21	5
1994 – 95	41.24	5.63
1995 – 96	19.92	3.46
1996 – 97	15.34	2.91
1997 – 98	14.5	2.73
1998 – 99	12.86	2.27
1999 – 00	19.78	3.78
2000 – 01	23.86	3.6
2001 – 02	16.55	2.38
2002 – 03	14.51	2.23
2003 – 04	16.19	2.82
2004 – 05	16.56	3.33
2005 – 06	16.98	4.17
2006 – 07	20.73	4.9
2007 – 08	22.65	5.49
2008 – 09	-	-
Median Values since 1995	14.92	3.33
Lowest Levels (October 1998)	10.27	1.73
Source RBI Handbook

Now, what this tells me is that Sensex was trading near its lowest multiples ever since the Indian economy opened up in both October 2008 and March 2009. The forecasted range for Sensex 2011 EPS is 900 to 1100 including the most pessimistic and optimistic scenario. Based on simple calculations the current level of 15 K discounts the most optimistic scenario with a P/E of 13.6, and that too almost 6 months ahead the curve. That means at current levels we are almost tilting towards the over valuation zone if we take into account the EPS and growth estimates for current Fiscal.

It is entirely possible for us to trade at higher levels and make further gains, but for that to happen either we shall trade at premium from our historical levels or the growth in earnings has to beat the estimates.

Markets level are a function of both facts and hope, however an excess of any factor may lead to irrational exuberance and deviation from fundamental reasons for investing.