Analysts widely believe the Indian stock markets are currently expensive, following a significant rally. However, when compared to valuations of previous years, the current valuations are still relatively lower.
In January 2022, India's benchmark Sensex was trading at about 58,000 points, with a trailing 12-month price-to-earnings (PE) ratio of 28x. By July 18, 2023, the Sensex hit the 67,000 mark, with a trailing 12-month PE ratio of 24.7x. Back in April 2021, the Sensex was at 48,780 points, and its PE ratio was 33.5x.
Hemang Jani, an independent market analyst, said valuations are currently not as stretched as they were during the high of January 2022. The Sensex is trading at a 12-month forward P/E (price-to-earnings) ratio of 19.5x, which is a 5 percent discount to its own long-period average (LPA).
Interestingly, the Sensex's earnings per share (EPS) grew by about 22 percent during FY23, reaching Rs 2,688, outperforming market returns of about 15 percent over the same period. This indicates that valuations are more reasonable now than they were at the peak in January 2022.
However, relative valuations are still at a premium. The MSCI India trades at a 100 percent premium to the MSCI Emerging Markets. That compares with an LPA of 70 percent. In this case, the average premium is for the past 10 years.
Despite the elevated premium, it is expected to sustain due to favourable macroeconomic and microeconomic factors, and better earnings visibility, Jani added.
Midcaps and small-caps
There is a similar trend in the case of the BSE MidCap and SmallCap indexes, which have both surged 24 percent in the past four months. As of now, they are trading at 25x and 26.7x multiples, respectively. However, in September 2021, their trailing 12-month PE ratios were higher at 35x for MidCap and 42x for SmallCap.
In April 2021, the MidCap and SmallCap indexes traded at about 20,300 and 21,670 points, respectively, with PE ratios of 57x and 77x. Those high multiples were because of depressed earnings due to Covid.
"Midcaps are quoting at higher valuations versus large caps, but that’s a typical scenario – when interest rates peak out and there is stability in macros, investors’ appetite comes back (seen in strong SIPs in equity midcap schemes and PMS AIF flows) and that is what is reflected in the midcaps performance," Jani said.
Analysts expect that the rally in the midcap and small-cap space is likely to continue. Amar Ranu, analyst at Anand Rathi, advises investors not to invest all their funds at once. Instead, he recommends adopting a staggered approach to build an equity portfolio.
He suggests investing 25-30 percent of the desired amount upfront and gradually adding the remaining funds over the next 3-4 months.
"Throughout this process, it's essential for investors to be mindful of their asset allocation, taking into consideration their individual risk profile. By following this staggered approach and considering their risk tolerance, investors can build a more balanced and well-structured equity portfolio," Ranu added.
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