By Prakarsh Gagdani
The Indian equity market is having an unprecedented run since the past few quarters. The bulls are not losing steam even at global shocks. The domestic institutional investors are stronger than ever before.
With the progressive Delhi policy makers firmly in shape and the best growth outlook in the world, Indian equity market valuations are touching new highs every day.
Now the pertinent question is what does this mean for an investor at this juncture. Have we entered a prolonged bull-run that we saw in the middle of the last decade or the lofty valuations would just crash without a hint?
Let us analyse this. As per our in-house research market valuations are significantly above long-term average currently with almost 30 percent of the stocks trading at over 40 PE, the highest ever.
The trailing PE for the BSE500 Index (or BSE200 for that matter) at ~26x the highest ever. In December 2007, the median PE for the market was 21x and 24 percent of the stocks were trading over 40x trailing PE.
Therefore a large part of the market is indeed expensive even by historical standards.
Does high valuation necessarily imply a crash? Probably not. This is because with all growth engines fired up, massive domestic demand and a young population, India is a dream for any business entity.
Well managed companies would easily perform better than their priced in valuations. However, what we can say with reasonably high confidence is that high current valuations mean all the high valued stocks may not match the priced in future returns.
From an investor’s perspective, this is the time, when you need to separate the men from the boys.
When stocks trade at high multiples, they need to deliver strong earnings growth for several years – companies need to be many times their size in the next decade.
One way to find such stocks is through their strong earnings delivery in the past. While I would remain stock neutral, if you do a little research, there are many successful stories right there which have delivered better than expectations.
They include many domestic consumption themes, stocks of visionary companies, stocks of greatly managed companies, stocks of innovative companies and stocks of many successful Indian MNCs. There are plenty of such stories that can be bought into even today and they wouldn’t disappoint you a decade later.
For example, for a stock currently trading at very high valuation say at 50x (trailing) earnings, it would require its profits to compound at 20 percent over the next decade.
The stock to trade at more than 25x in 10 years from now for an investor to make sustained returns. There are many such bets waiting to be discovered. Happy investing in stocks.Disclaimer: The author is CEO, 5Paisa.com. The views and investment tips expressed by investment experts on moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.