What is Sensex P/E: Sensex P/E Hits 20 Year High
As the PE ratio of Sensex soars to a 20-year high indicating extreme overvaluation, experts say that a stock market correction is in the offing, as such levels are unsustainable. The Sensex PE has soared to 28.29 in FY20, it’s highest in the last 22 years. “The market is indeed overvalued at a PE of above 28. Markets are extremely fragmented at the current moment and Sensex cannot always remain in its fortified island at such high levels. There is a very high likelihood that stocks will crack and correct to their mean PE levels within a short span of time,” Umesh Mehta, Head of Research, SAMCO Securities told Financial Express Online. The Price to Earnings (PE) ratio compares the market price of the share in relation to its earnings. The ratio implies the amount an investor is willing to pay to earn one rupee in earnings (profit). Therefore, if the PE ratio for Sensex stands at 28, investors are willing to pay Rs 28 for one rupee profit collectively earned by all companies that comprise the Sensex.
Explaining the reason behind the excessively high PE at present, investment advisor Sandip Sabharwal noted that losses reported by stocks like Tata Motors and SBI have skewed the ratio, which is unlikely to repeat in the future. “Sensex PE is misleading as over the years more and more high PE stocks have to go added to the Index. Due to this, the PE looks higher than what it would be in normal circumstances,” he noted.
Experts concur that the valuations remain stretched at the current levels. On one hand, few select large caps in key sectors like BFSI, IT and Oil & Gas which constitute majority of weight in the index have been taking the markets higher, while the other sectors like Auto, Pharma, Metal and Telecom has already witnessed considerable correction over the past 1-2 years due to their respective challenges, Ajit Mishra, VP – Research, Religare Broking told Financial Express Online.
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Notably, the top 10 index constituents have been getting a lion’s share of incremental flows from both domestic as well as foreign funds, says Jatin Khemani, founder and chief executive officer, Stalwart Advisors, an independent equity research firm registered with the Securities and Exchange Board of India. “This has elevated their multiples as well as that of the index,” Khemni told Financial Online, adding that the story outside the top index stocks is the exact opposite, as the broader markets have seen meaningful outflows contracting their multiple below the 5-year average. “The re-rating that happened over the last cycle has been completely washed away bringing valuation of broader markets back to reasonable levels,” he said. However, the Sensex PE ratio serves little purpose for the bottom-up stock pickers, says Khemani. “What matters much more is the quality, growth outlook and valuation of companies one holds in his portfolio,” he added.
So what should investors do, to mitigate the risk of a loss? “Investors should do systematic investment plan (SIP) in midcap funds or thematic funds like pharma sector funds as risk-reward is favorable in those at current levels,” Vikas Jain, Senior Research Analyst, Reliance Securities told Financial Express Online. According to the expert, earnings have to catch up from current levels otherwise there will be a price to earnings (PE) contraction which will lead to a sharp correction in the Sensex. “Midcaps and small caps have witnessed deeper correction over the past one year as issues with respect to earnings decline, governance issues and sharp outperformance in CY17,” he said, adding that markets will keenly watch the first-quarter earnings of FY20 and global issues with respect to trade war and higher crude prices from current levels, going forward.
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What’s Driving The Investor Bet On Sensex Stocks
Mint takes a look at what is driving the stock market.
1) Are the current levels of the stock market justified?
Till now, in fiscal 2019-20, the price-to-earnings (P-E) ratio of the 30 shares that constitute the BSE Sensex, India’s most popular stock market index, has been at 28.17. The P-E ratio is the market price of a share divided by its earnings per share. When investors buy a share at a certain price, they are basically paying for the future earnings of that company. So far this fiscal, investors have paid ₹28.17 on an average for every rupee of earning for Sensex shares. This is the highest average P-E ratio is more than 20 years. Thus, it’s important to understand what exactly the stock market is paying for.
2) Why are investors paying such a high price for shares?
A high P-E ratio means that while share prices are going up, earnings of firms are not. People investing in the stock market hope that as Prime Minister Narendra Modi has a bigger majority this time, his government will initiate another round of reforms on labor, land, and capital. These reforms will improve the ease of doing business. This will help companies expand businesses and spur the launch of several new businesses, thus creating jobs. The creation of more jobs will help people earn more, leading to greater spending, which will benefit businesses and improve their earnings.
3) Have P-E ratios ever been so high in the past?
P-E ratios were high in mid-2000 when the dotcom bubble was on, and on December 2007 and early January 2008, when the market was rallying, before the financial crisis set in.
4) What are the other reasons for such a strong market?
In the last decade, the central banks of Western countries, led by the Federal Reserve of the US, have followed an easy-money policy. This allowed foreign investors to borrow money at low-interest rates in the West, buy shares all over the world and drive up share prices in the process. In the last few months, the Federal Reserve has more or less signaled that this easy money policy is likely to continue. This has given further hope to stock market investors in India.
5) What about the consumption slowdown?
Investors expect the new government to tackle the consumption slowdown by raising its spending. This is a short-term hope that has driven up the stock market, despite the lack of earnings growth of firms. The government needs to avoid the mistakes made in 2008-09 when it increased spending and pushed public sector banks to run an easy credit policy. This later led to high inflation and massive bad loans of those banks.
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