Raamdeo Agrawal: Do not judge this market by its PE ratio

The Indian market has been on a upward ride ever since it crashed to 52-week lows of about 6,800 in February. Having risen about 30 percent since, it has led some analysts to wonder if the market has become expensive, especially since the long-awaited real turnaround in earnings is yet to take place.But Raamdeo Agrawal, Joint MD of Motilal Oswal Financial Services, says that one should not rely too much on traditional metrics such as price to earnings (PE) to judge whether valuations are expensive.For instance, the market is usually valued at either trailing (Rs 1,350 EPS in FY16, translating into 21 times PE for Sensex) or one-year forward basis (expected FY17 EPS of Rs 1,550; 18.3 times) but should earnings rise another 15-20 percent in the next fiscal, valuations would revert to mean of 15-16 times within 6-8 months on FY18 basis."Because earnings have been depressed [over the past few years], the price is looking high," Agrawal told CNBC-TV18 from the sidelines of a Motilal Oswal Investment Conference, adding that he would use another indicator -- marketcap to GDP, currently at a reasonable 73 percent -- to evalualate the market.Below is the verbatim transcript of Raamdeo Agrawal’s interview to Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: The mood has changed from your last conference to this conference, last conference we were at 52 week low and this conference we are at 52 week high. Do you see more gains for the market from here on? A: It feels very nice here. The all time high is not because of the conference, it is all because of the underlying trend or the negative interest rate, monsoon, and all sorts of things happening and global markets are also good. I think all the factors are in confluence right now and the mood is good. What I am seeing is that sector after sector: the impact of digital and what's going to happen to the financial sector or even the kind of developments in oil sector, a lot of these things are very positive and these are the companies which have been winning in last 8-12 months and we are seeing that those companies are reflecting in today’s movement also. So, very clearly, there are some segments of the market which are doing extremely well and some segments of the market, they are slow. However, the opportunities, like UltraTech Cement, we heard the presentation [at the conference]. For few years, the whole industry has been in low profitability situation. However, what has happened in China starting from 1990, we are at a consumption level of 1990 in China at about 250 million tonne. So, from there, it went 10x to 2.5 billion tonne of cement being consumed right now. So, that is a kind of positive we have. Housing itself can consume a 1 billion tonne. So, those are the kind of eye opener kind of situations we are seeing. Now, the issue is whether it is going to happen or not.Sonia: A lot of the market is still in denial about this rally. There are bulls but then there are very reluctant bulls as well. What is the sense you are getting, could this market surprise people on the upside and get into a multi-year bull market? A: I know one thing that at current levels of 70-73 percent of gross domestic product (GDP), market cap of GDP, earnings being depressed right now and we are looking at post monsoon inflation being coming down and lower interest rates and a lot of things, so, I would think that valuations are not elevated, though in terms of P/E, because earnings are depressed so the price is looking high. So, it is a relative stuff. If your corporate profit to GDP instead of 3.5 percent is 7 percent, the same PE multiple instead of 24 it will look like 12. So, right now, because of depressed earnings, you cannot say like any turnaround company when they make profit first year, the PE looks to be almost like 100 times. However, that PE has no meaning, it is not the normal PE. So, right now I would say the earnings are not normal and hence PE calculation is also not normal. It is not that we can ignore that entire PE but yet I think there is good room for the PE to be adjusted for the normalised earnings which I would think is about at least 25 percent. So, if you do about 16-17 times, we are talking about very normal kind of PE multiple at this juncture. Anuj: You had a lot of companies, 60 percent of India’s market cap was represented. I attended some of the presentations, I had my favourites but what were your favourites, which one did you like the most? A: I liked presentation of [NSE chief] Chitra Ramakrishna. First time I heard her speaking on NSE as a corporate and what is the potential of this monopoly exchange from India. So, that is a very good one. Yesterday was [HDFC Bank's] Aditya Puri; from his talk it was very clear that the banking opportunity with the PSU banks at standstill and foreign banks kind of reducing their operations here and economy on surge, the banks which are well positioned for risk management, offerings and the current profits, capital adequacy, I think the opportunity is very large, not only for him but all the banks, four to six banks which are operating in that segment, so, that was also very interesting. Rajiv Bajaj was just too good in terms of his presentation on strategy and how he thinks about his own business and entire two wheeler business. He had some radical remarks to make so he clearly scored; he was very popular among the crowd. Sonia: Generally when the markets hit a new high or 52 week high, there is a left out feeling from the retail community and there is a buyers panic that we see. That is just how things play out. What is the sense you are getting, what is the word coming in from domestic investors that have perhaps missed out on the last leg? Do you expect to see a buyers panic now? A: I am really confused this time to see the investor behaviour domestically. They have done so well and timing the correction also, probably that is lack of our understanding of the dynamics here. However, I don’t think there will be a buying panic or anything like that but they will stop selling. That itself will do a lot of good to the whole thing. Foreign institutional investors (FIIs) are buying and today domestics are selling, so, if they stop selling from where they will buy? They have to put the stock prices much higher to get the stocks. So, I think not selling itself will be a big trigger and if they actually get onto buying because somebody who is selling right now to turn them on to buy convincingly, you need some change of the facts.Anuj: When we came to your office for curtain raiser, you told us that you were meeting Vishal Sikka next day for that analyst meet. You spent the day with him, is your confidence intact in Vishal Sikka himself, in the Infosys stock, do you see the stock bouncing back? A: I was very impressed. First time I listened to him. He is very impressive and his thoughts are very clear. They are clearly creating next generation services company out of Infosys. There is a challenge, there are two parts of it, one is the existing legacy business which has to be kind of reshaped so that it is more relevant in the future and then they are talking about completely new setup businesses, so called digital and new business, new services which are coming up. So, I think the mood is cautiousness and my sense is that they are talking upfront the bad news and not talking so much the good news, the deal wins or the ramping up. So, if out of 100 clients or top 20 clients, one client is doing badly, they are kind of telling you everything about that one client. A lot of people are thinking that what is happening to one client probably may be happening to many more clients. However, what are the good things happening to many good clients that is not being measured properly. So, mentally it is very difficult to figure out how much to give negative marks for one client and how much positive you should give for 99 clients and that will reflect only in the quarterly results where he is saying that my growth in Q2 will be better than Q1.However, it is all for the analyst and all those who do spreadsheet and those who stay with them. However, one thing is sure that for some time it will not be a roaring growth. 10-15 percent is fine but thinking about only 20-25 percent growth, I think that hyper growth era at least is not there right now. Anuj: Last conference when we went and did [CNBC-TV18's] Closing Bell there, the Nifty was at 7,800, mood was somber and now we are at 8,800. Do you see 9,800-10,000 by next conference? A: Whatever we see in terms of six months to one year targets – mood is good, I can only feel that downside is limited, upside is very good and particularly upside for a well chosen portfolio is extremely good. So, one has to be -- though the market might stay here or maybe 9,500 or 9,700 or even 10,000 but that 10 percent move is not that important in the sense that if you make 10 percent I would not think that you have done wonderfully well in the market. However, in that 10 percent move I see 20-25 percent kind of return for a well chosen portfolio.