Corrective phase is over – It's now time to buy

Corrective phase is over – It's now time to buy

The NIFTY 50 is quoting at P/E multiple of 23.6 times. In January 2008 the markets topped out when P/E multiple was at 28.3 times. Historically, markets tend to top out between 23-28 P/E multiples. Let us see if it is right to conclude that markets are trading at frothy valuations just based on one criteria –P/E multiple.

These days every discussion on the trend of the market ends up in a conclusion that markets are expensive and are bound to correct. This argument is based on the premise that markets have run up too fast without any meaningful correction from February 2016 lows and is now quoting at very high PE multiples. It is also argued that markets are trading at a substantial premium to other emerging markets.

The Nifty 50 is currently quoting at PE multiple of 23.6 times. In January 2008 the markets topped out when P/E multiple was at 28.3 times. Historically, markets usually tend to top out between 23-28 PE multiples. Let us see if it is right to conclude that markets are trading at frothy valuations just based on one criteria –PE multiple.

At the top of the business cycle in 2007-08,the corporate capex was at its peak owing to record high capacity utilization levels.The earnings had grown consistently at over 20 percent for past three years. The scenario is very different now. Corporates are still not ready with the fresh round of capex as capacity utilisation continues to remain low at around 70 percent.

The infrastructure spend is primarily in the form of government spending for building public infrastructure. This situation is about to change as corporate sector focuses on deleveraging their balance sheets, preparing for next round of growth.

Most large corporates share optimism about the potential of India’s economy amid strong leadership at the Centre.This is reflected from the fact that the promoters of one-fifth of the BSE 500 companies have raised stakes indicating confidence in their company’s growth (Source: Economic Times).

The credit growth in the economy continues to remain sluggish at around 10 percent as against mid-20s in 2007-08. The banking sector in India is undergoing a major clean-up exercise. This clean-up phase will build the stage for the next round of economic growth.

The PE multiples on an absolute basis tend to look stretched during the phase when the economy is on the cusp of a major recovery but corporate earnings are yet to show meaningful growth. India is going through such a phase now. The current high P/E multiples are just an indication that investors anticipate strong and sustainable growth in earnings in the years to come.

Market valuations are not looking extremely stretched based on other valuation metrics such as PB and dividend yield. On a Price to Book (PB) basis NIFTY 50 is currently quoting at 3.3 times as against 6.6 times in January 2008. The dividend yields are currently at 1.66 percent as against 0.82 percent in January 2008.

The global economy is still not out of woods. The major developed economies are struggling to revive growth. The vote on Brexit has created a fresh round of uncertainty. Most of the emerging markets are yet to stabilise in the low demand environment amid highly depressed global commodity prices.

China, too, has its own set of macro-economic problems such as over-capacities, huge debt, amid falling demand. In such an uncertain global scenario, India is one shining star which offers an excellent investment opportunity for the investors, thereby deserving premium valuations over other emerging markets.

India’s macro factors have improved drastically over past couple of years and government is determined to push through reforms. The positive impact of GST on the economy will be unleashed over next couple of years. The revival in earnings of the Indian corporates may have got deferred by few quarters, but the recovery is surely on track. The foreign investor’s interest continues to remain high towards Indian companies

World over interest rates are at multi-year lows. In India too interest rates have fallen over past few years. The cost of capital is expected to come down further post bountiful monsoons. Global markets are flooded with liquidity.The fall in cost of capital is bound to result in higher earnings growth for India Inc., thereby supporting higher valuation multiples for Indian equities.

The retail public is currently participating in the equities primarily through mutual fund SIP route. Their participation is low in direct equities. Typically, bull markets top out with aggressive participation from retail investors in the direct equities. This trend is clearly not visible now.

The roaring bull market is ahead of us. The recovery of earnings growth and tsunami of global liquidity will drive Indian markets to the new highs. However, the consolidations and corrections will continue to remain integral part of this multi-year bull market.

Happy Investing

Source:Moneycontrol.com