Tuesday, July 08, 2008

Sensex Valuations

Often, we hear people talking about sensex PE and pointing out how the market is overvalued in comparison with other economies They are implicitly refering to the theory of mean reversion and implying that the markets would correct downwards.

However they completely ignore the fact that that the underlying economy is still growing at 7-8 percent in real terms and therefore the premium over other markets is justified.

Anyways, what i really wanted to point out was that they also imply, that along with the sensex, other stocks should fall as well. While their movement is correlated to an extent, one needs to take a look at the underlying valuations of these stocks independently of the sensex. The sensex PE is at 13-14, but other stocks with similar growth performance are languishing at a PE of the order of 5-6 or below. Which would make sense if the markets were expecting a dip in earnings. i.e. profits next year being lower than in the previous year and not just a slow down in growth, in the short term.

If you were to do a DCF valuation, a short term performance blip anyways has low sensitivity to the overall valuation as a large majority comes from the terminal value. So if structurally the story is intact and long term growth is not threatened, which I believe is, I would be a buyer in these markets

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