ARE THE VALUATIONS JUSTIFIED AT 20000 SENSEX???

For the histories in record stock market have witnessed lots of dynamism and revelations beyond human imaginations.

Always in the market there remains two schools of thought, one "Bull" and another  "Bear".  Market ( comprising of the behaviors, actions and reactions of both Bull & Bear) dwindles on fundamentals, sentiment, newsflow, participants, liquidity and numerous other functions, betond imagination and calculations. The interplay of the two schools of thought carries a great deal of market composition. Hence at a time you get the news & information about both "Bull" and "Bear" school of thought and this endless fight between the duo, brings the small as well as wild swings in the market.

Imagine the absence of one. Every one is very optimistic, full of enthusiasm and zeal, every one becomes buyer, even the seller stops selling and turn outs to be the buyer ( absence of selling) there will be upper circuit ( which happens with individual stocks, very often). Some time it happens with the entire market, but never with all the stocks traded in the market.

Conversely imagine that there is extreme pessimism in the market. Every participant is worried with the view and gloom over the uncertainty, there will be lower circuit to individual stocks, or a market as a whole, but not to every stock of the market.

Between these two extremes market remains in the "continuous state of  unequlibrium" and dwindles on the either side of tug-of-war between "Bulls" and "Bears", depending on the in-numerous factors, some of which we use to calculate the probability and the outcome out of uncertainty.

When we calculate the outcome, we use certain parameters which are coherent with the study and realistic outcomes. Statistics is a study which deals to conclude or deduce certain inferences, BEYOND THE QUALITATIVE ASPECTS.

A survey of 10000 road accidents show  that " number  accidents taking place on side of the road is far more than the accidents on the road".

A statistical meaning and inference of this analysis could be " Is it safer to walk on the street????" 

and the answer is obvious to every one.

Similarly, the data analysed by using the statistical tools and mechanics to picturise that "market is at top trading around 24 times and soon shall crash to the median 17 times" seems incomplete, lacking the dynamics which may be misleading. 

The thumb rule to the justification of valuation in reference to EPS and PE lies on the inference that.

Valuation= EPS * PE

Currently the EPS of the Sensex= 1000 for the current year and projected EPS for the next financial year (2011-2012) is 1200.

On this basis currently we are trading around:

PE = 20000/1000= 20 times (and not 24 times).

Hence valuations are neither cheap nor stretched and justified by the earnings. Moreover market in no circumstances will move above 23-24 times or 23000 to 24000 ( extreme case scenario) before march 2011.

Now considering the growth of 17% CAGR one year forward earnings come to be = 1000 + 17% of 1000= 1170. Hence valuations to the tune of 20 times of 1170= 23400 will be justified from April 2011 onwards, and will be updated/adjusted from time to time after getting the actual earnings.

When GDP is growing at the rate of 8.9% the CAGR translates to around 20 to 21 . Hence in optimism takeing CAGR= 20 the projected EPS ( for FY2011-12) shall be = 1000 + 20% of 1000= 12000. On this basis 20 times of the optimistic EPS ( projected) valuation of the Sensex comes to be= 1200*20= 24000. Hence in the NORMAL case SENSEX shall go to 24000 next year. If we consider the optimistic case we shall see the valuations around 24*1200=28800 ( which will be stretched and not cheap).

From every previous crash or fall in past and now:

1. There has been tremendous change in the trade, commerce and business of India Inc from then till now.

2. The GDP growth rate of India was far below than the other developed nations at that time, hence it was perceived as a closed or developing economy. Things have gradually changed in the favor of India and it is considered more preferred destination for the investment in the world when compared on the other grounds too. 

Even the most optimistic analyst of US now talks about the GDP growth of 3% and the most pessimistic view of GDP growth in India talks about 7%-8%. 

Murky global situation and insulation of India against the global risks is well accepted by the analysts.

On the other side of the coin there remains some hard fact realities and threats and challenges to Indian Economy like rise in crude oil above $100. What will happen to inflation after HY2011?  Rising cost of input to industry shall damper the earnings of the India Inc , which might result in earnings down grade and the optimism shall turn to pessimism for some time and many other factors which are working globally and domestically which might affect the earnings ( indeed NOT THE SCAMS!!!!!!!!!!).

To conclude, Sensex at 20000 and Nifty at 6000 is not stretched and justified by the earnings. ( That is why the market perceived Nifty at 5690 as reasonable and bounced back after "the forced correction" ) to 6070.

As the market anticipated the economy 6 months before. Its logical and reasonable of talking the valuation of 21000-22000 ( Nifty 6400-6500) by next 2 months( Dec & Jan). As far as dollar index doesn't move very high resulting in dollar outflow, India will see significant investment from FIIs and other institutions. 

There will be chances of huge or large correction if the market reaches 22500-23000 by next 2 months and in that case the above statistical study may come to TRUTH resulting in crash to 17000 or even to 16000, but it doesn't seems right now.

One must always  have caution while investing in the "Stock Market" because for getting higher returns one has to take higher risks.

Safe Harbor Statement:
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.Nothing in this article is, or should be construed as, investment advice.

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This is neither an offer nor a solicitation to purchase or sell securities. The information and views contained on this blog are believed to be reliable, but no responsibility (or liability) is accepted for errors of fact or opinion. Writers and contributors may be trading in, or have positions in the securities mentioned in their articles. Neither I (Vikas Srivastava) nor any of the contributors accepts any liability arising out of use of the above information/article. Reproduction in whole or in part without written permission is prohibited.