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BW Businessworld

Going Back To Fundamentals

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  Barring the scary late-October crash, the past three months have seen the stockmarkets on an automatic gear driving the steady flow of foreign institutional investor (FII) investments. But the second half of January will see fundamentals come into the limelight once again as the listed companies’ financial results for the quarter ended December 2008 come in.

Valuation of stocks by FIIs and domestic institutional investors has risen sharply and sustained ever since net profits and earnings per share (EPS) rose sharply in the last quarter of FY 2008-09. The price-earnings (P-E) ratio of the 50-stock S&P CNX Nifty index shot up by 40 per cent during the April-June quarter in 2009; Nifty stocks’ aggregate EPS also grew by 7.8 per cent over the October-December 2008 quarter and aggregate net profit grew by a hefty 28 per cent in the same period.
The first two quarters of FY 2009-10 have brought out the difficulties India Inc. is having in sustaining high growth in profits as they stuttered.
Yet the Nifty P-E has continued going up crossing 23 on Christmas eve, the same level it had touched on 17 October before global jitters brought Indian markets down sharply in the following 10 days. In the past five years, Nifty P-E had peaked at 27.9 on 11 January 2008 before the big crash of that year.
High global liquidity in November and December has prevented prices from falling, but it has also meant that valuations have got stretched. “Most of the consensus earnings upgrade forecasts for the next two years is based on looking at sharp revival of growth in second half of the current financial year,” says Gaurav Dua, head of research at Sharekhan. “That is why the December 2009 quarter figures will be watched very closely.” He adds that these results will not only have to meet Dalal Street’s expectations, but also be much ahead.
Indian equity market has always been considered expensive, but this has never deterred FIIs. “Global investors focus more on their confidence in their economies, and if that is good they come to emerging markets notwithstanding high P-E ratios,” says Saurabh Mukherjea, head of India equities at Noble Group.
But if corporate earnings falter, or do not meet street expectation, then any liquidity-driven sustained rise in prices will lead to the Nifty P-E touching stratospheric levels of 25 and above. In its October 2009 India Strategy report, Enam Securities indicated that the Indian market would see a sharp upward spike “if global liquidity continues to seek strong domestic growth and ‘thematic investing’ starts overlooking valuations”.
As the valuations of large-cap stocks aim to cross their 2007 highs, the small-cap stocks, which are largely ignored by FIIs, are beginning to get noticed by domestic investors. “I have got returns from my small-cap investments that are more than 80 per cent what Sensex gave in the past one year,” says Kishore Ghiya, a Rajkot-based high-networth investor, who does not invest in large cap stocks. The BSE Small-Cap Index is presently trading at a P-E of about 17.5, less than that of Nifty or Sensex, but much higher than its March 2009 level of 6.5. The P-E of the Small-Cap Index has almost tripled during this time, whereas Nifty P-E only doubled, which indicates the need for investors to be watchful. 
The suspense will be over once the Q3 results start coming in.
(This story was published in Businessworld Issue Dated 11-01-2010)

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