Equity valuations once again on the rise even as profit moderates

Equity valuations are once again on the rise, after they cooled down in the second half of 2021 and the first half of 2022.
 

The BSE Sensex trailing price-to-earnings (P/E) multiple has risen to a 17-month high of nearly 25x, from 23.7x at the end of December 2022 and 21.6x at the end of June 2022. Similarly, the index closed on Friday with a trailing price-to-book (P/B) value ratio of 3.6x, up from 3.4x at the end of December 2022; it is the highest since December 2021.
 

A steady rise in the valuation has been largely due to higher stock prices, and not because of faster growth in corporate earnings. The overall corporate earnings are showing signs of stagnation, against the trend of double-digit earnings growth in 2021

and 2022. 
 

The underlying earnings per share (EPS) of the BSE Sensex on a trailing 12-month basis is up just 3.4 per cent in the past 12 months and down nearly 2 per cent from the highs made in May this year after the end of the March 2023 quarter earnings season.
 

In contrast, the index EPS was up 22.8 per cent during CY22 calendar year and 46.6 per cent during CY21.

The Sensex ended Friday with trailing EPS of 2,653 per unit of the index, against Rs. 2,665 a year ago and Rs. 2,567 at the end of December 2022.
 

The index EPS tracks the combined earnings of the 30 companies that are part of the index and is calculated by dividing the index closing value by its P/E multiple. The stock exchange provides the valuation ratios after the end of every trading session.

According to analysts, the apparent stagnation in the overall corporate earnings is due to lower-than-expected corporate profits in the past few quarters, including the April-June 2023 period (Q1FY24).
 

“The overall corporate earnings were up 9 per cent in FY23 against Street expectations of 16-17 per cent growth. Analysts now expect corporate earnings to grow by 18-10 per cent in FY24. But corporate results for Q1FY24 have failed to meet initial estimates, putting a question mark over the full-year estimates," said Dhananjay Sinha, head strategy and research at Systematix Institutional Equity.
 

The growing dichotomy between corporate earnings and rich stock valuations has, however, started to weigh on stock prices. The bull run has entered rough weather after four consecutive months of winning streak. The benchmark BSE Sensex ended in the red in five out of the past six trading sessions and down 2 per cent during this period.
 

The index closed at 66,160 on Friday, down 1,412 points from its lifetime high closing of 67,572 on July 20. The index is up 2.2 per cent during July, so far, compared to a 3.4 per cent rally in June.
 

The bulls, however, remain hopeful of a better earnings growth in the next three quarters of FY24 and there is no significant cut in full-year earnings estimates and this explains the index higher valuations despite stagnation in earnings.