P/E ratio drops to five-year low

Dips below 9, future depends on the general election. The average price-to-earnings (P/E) ratio, an indicator of market valuations, has fallen to a five-year-low of 8.71, indicating that investors are willing to pay much less for equity at present. The biggest fear now is that the current economic downturn may continue till 2009-10, and equity investments are unlikely to fetch good returns in the next one year.

The P/E ratio has fallen across the board, irrespective of sectors, with shares of all large-, medium- and small-sized companies – both private as well as public sector – taking a hit due to negative investor sentiments. The current P/E ratio of 8.71 is in stark contrast to its peak of 22 which was set on January 8 this year.

Even the 30 shares that make up the Bombay Stock Exchange Sensitive Index have seen their combined P/E ratio dropping to 10.15 from over 25 as of January 8.

As many as 102 sectors out of 130 are trading at a P/E of below 10 now compared with only 24 a year ago.
 

WEAK SIGNALS
Sector	Price to earnings (P/E)
	A year ago	Current *
Construction	65.13	15.96
Mining	34.61	9.15
Engineering	33.80	8.12
Media - entertainment	31.63	9.07
Capital goods	30.98	14.92
Construction housing	19.76	5.36
Information technology	16.70	8.33
Auto ancillaries	15.24	8.75
Banks	14.60	5.21
Steel integrated	11.21	2.97
BSE Sensex	20.12	10.15
* as on March 9, 2009 and based on net profit for trailing twelve months ended December 2008

In simple terms, these low P/E ratio figures show that an investor who was willing to pay Rs 22-25 for every rupee an individual share earned a year ago, is willing to pay only Rs 8.71-10.15 for the same rupee-earning now.

Going forward, the economic downturn is expected to aggravate further if the upcoming general elections throw up a fragmented mandate.

The equity markets had gone through a similar grind five years ago when the National Democratic Alliance (NDA) had lost the general elections and the victorious United Progressive Alliance (UPA) had already made it clear that it was against the blanket sale of public sector undertakings (PSUs).

The resultant thumbs-down by investors to the incoming government pushed the markets down, with the P/E falling to 9.75 in June 2004.

Market players fear a repeat of that meltdown, given that coalition politics and a fractured outcome have become the realities of the modern Indian political scene.

What compounds the problem, traders point out, is that the markets are already in the grip of bears. General elections will be held from April 16 to May 13, and the results will be announced on May 16.

If one goes by the current market’s price-to-earnings and price-to-book value, however, there are indications that the equity markets are in the process of bottoming out.

According to Citigroup Asia-Pacific’s equity strategy reports, there are, among others, four indicators that determine when to turn bullish in the Asian region. The first is timing, according which things will get more interesting in the next few months. The second factor is valuation which, though very cheap at present levels in Asia, will still not drop further to the historic lows of prior recessions, be it 1975, 1982 or the Asian crisis of 1998.

The third indicator is a perceived bear market exhaustion, which means that new 52-week lows – as compared to those of October 2008 – may not be breached. Historically, markets have always bottomed out whenever 30-40 per cent of the stocks hit a new 52-week low.

According to data analysis, 70 per cent of stocks were already trading at 52-week lows in October 2008, as against to 38 per cent in the current month.

The fourth and final parameter is the general apathy towards equities which, while still on the rise, has not yet reached the point where investors are completely averse to this asset class.

So, according to market players, while the short-term outlook remains negative, there may just be a possibility that the markets have bottomed out.