Sensex: Are the BUY screams getting louder?

Over the past few months a lot has been written about investing in equities as an asset class. While some investors are finding value in the markets at current levels, others are completely staying away or have been reducing their exposure to equities as an asset class on the whole.

Data Source: ACE Equity

This chart above represents the movement of the Bse-Sensex over the past one and a half years. Clearly, the volatility perhaps justifies the skepticism as to why investors (especially retail investors) have been shying away from the Indian equity markets in recent times.

But then we saw the following chart, and thought it best to go back to basics.

Data Source: ACE Equity; * - TTM average since January 2000

The chart above includes certain data points. One is the Sensex's price to earnings ratio (P/E Ratio) since January 2000. Secondly, the EPS of the Sensex companies is provided in the chart. Also, the average P/E ratio (since January 2000) of 18.7 times is marked to make the understanding more meaningful and easier.

Renowned fund manager Mr. Prashant Jain (of HDFC Mutual Fund) was recently of the view that present times provide Indian investors one of the best opportunities to buy Indian stocks. His view for the same is on account of the Sensex trading at very attractive valuations.

From the chart above, one can gauge that purely from a valuations point of view, the markets are trading below the average PE. Now, this would be justified if the earnings are expected to decline sharply, which would then lead to the valuations to fall close to historical levels. But a likelihood of a substantial decline in earnings is low.

Since 2000, the Indian markets and Indian companies have been through a lot. Leaving valuations aside, one can notice that there has been a steady rise in the earnings of the companies over the years (barring the few blips in the middle). Slowdowns, high inflationary environments, high competition - all these factors have been experienced by these companies.

And as you would very well know, stock prices at the end of the day reflect the earnings of companies.

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Now, while a discussion on what would be the earnings and subsequently the EPS going forward is debatable, we thought we leave that topic for another day. Instead we could look at what the Sensex seems to be valued at with different growth rates in earnings.

As of last week i.e. 8th June 2012, the Sensex ended at 16,719 points. The index's PE multiple stood at about 16.3 times (a figure that is anyways lower than the average of 18.7 times). The EPS turns out to be Rs 1,023 at present.

Earnings growth

	Current	5%		10%		15%		20%		25%
Parameters	Mar-12	Mar-13	Mar-14	Mar-13	Mar-14	Mar-13	Mar-14	Mar-13	Mar-14	Mar-13	Mar-14
EPS	1,023	1,074	1,128	1,125	1,238	1,176	1,353	1,228	1,473	1,279	1,598
P/E	16.3	15.6	14.8	14.9	13.5	14.2	12.4	13.6	11.3	13.1	10.5

Data Source: ACE Equity, BSE, Equitymaster Research

The table above shows the valuations of the Sensex in relation to the compounded growth in earnings of companies over the next two years i.e. FY13 and FY14. It must be noted that these valued have been calculated with the Sensex at 16,719 points, which is the closing level of last week.

We would like to discuss some other data points here as well.

Since January 2000, there have been more than 3,100 trading sessions. Out of those, the Sensex has been trading below the long term PE average of 18.7 for about half the number of days, thereby providing investors a good enough opportunity to buy into the market at average levels. However, when compared to the current PE levels i.e. 16.3 the Sensex has been trading below such levels for only about 28% (close to a quarter) of the time since January 2000. In other words, the opportunity has been this good only about one out of four times on an average.

Keeping these points in mind, long term investors in India who are skeptical of entering the markets would do well to keep in mind that current valuations are close to their three year lows as well. These aspects not only provide some amount of cushion in terms of margin of safety but also provide good opportunity to build a solid portfolio from a long term perspective. 

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