Benchmarks' P/Es at 30-month highs

The average price-to-earnings (P/E) ratio, an indicator of market valuations, has surged to a 30-month high. Both benchmark indices, the BSE Sensex and the S&P CNX Nifty, are trading around 21 times. This ratio had fallen to a five-year-low of around 10 in March 2009 from over 22 times in January 2008.

The current ratio is on the higher side and reminds of the boom-time valuation when benchmark indices saw a sharp correction after reaching a peak in terms of the P/E multiple.

The downside is limited this time, as the earnings growth rate for Sensex companies is expected to be over 20 per cent each in the next three years. Earnings growth had been the foundation of Indian equities during the upcycle of financial years 2003-2008, with a compounded earnings growth rate of over 25 per cent. After the global financial crisis, Indian earnings flattened for two consecutive years on account of a poor commodity cycle.

With the world economy showing signs of improvement, the second quarter of 2011 should mark the beginning of earnings growth. According to the revised earnings estimate posted by Indian and foreign broking houses after first-quarter results, the 30 Sensex companies are expected to report a 24 per cent rise in net profit in the current financial year, from the earlier estimate of 10-15 per cent. The earnings growth is expected to be over 20 per cent for the financial year 2012.

At the current levels, Sensex and Nifty are within a few per cent of their two-year highs, and both have gained over 20 per cent so far over the 52-week low of November 2009.

The market is trading at 16.86 times FY11 forward earnings, a slight premium to the long-term average of over 15 times. Even so, Sensex companies are relatively cheaper on the basis of FY12 forward earnings, trading at 14.24 times.
   

EXPENSIVE, BUT WORTH IT  FORWARD P/E OF SENSEX STOCKS
	Estimated P/E ratio		Estimated earnings*
	FY11	FY12	FY11	FY12
Bharti Airtel	18.32	14.78	-20.11	23.96
HDFC Bank	26.07	19.94	34.11	30.72
ICICI Bank	23.04	17.66	26.41	30.42
Mah & Mah	16.14	14.30	16.90	12.89
Maruti Suzuki	15.89	14.11	-5.81	12.63
Reliance Ind	14.54	12.04	24.90	20.70
State Bank	16.46	12.77	24.83	28.88
Tata Motors	7.20	6.23	360.59	15.60
Tata Steel	9.09	6.52	1919.48	39.38
TCS	21.59	18.87	14.39	14.43
BSE Sensex	16.86	14.24	23.50	18.42
* Estimated earnings growth rate based on analysts reports

The European and US markets are comparatively cheap, trading at a P/E of 11-13 times earnings for calendar year 2010 (CY10) and 10-13 times for CY11. However, the earnings growth for US and European markets is unlikely to be as robust as ours. According to a Bloomberg estimate, the earnings of Dow Jones companies are likely to be up by around 12.5 per cent in CY11, compared to 24 per cent for the 30-scrip Sensex. The index-based companies in England, Germany and France are expected to show earnings growth of 11-15 per cent in CY11.

Equity analysts expect substantially strong earnings growth from automobile, oil marketing, technology, metal, power and realty companies, besides banks. Telecom is expected to be the most laggard sector, but capital goods, engineering and construction, and fast moving consumer goods should do well. Among Sensex and Nifty companies, the growth in Bajaj Auto, Dr Reddy’s Labs, Cairn, Ranbaxy, Tata Steel and Tata Motors is expected to be over 30 per cent each in FY11. The earnings growth rate is expected to be over 30 per cent in FY12 for Cairn, DLF, ICICI Bank, Sterlite Industries and Tata Steel.