What Sensex level is your broker selling you? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

What Sensex level is your broker selling you? 

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In this issue:
» It may take just one big macroeconomic risk to spoil the party.
» Is the infra story being oversold?
» GST a priority, but challenges galore!
» JNNURM to be scrapped?
» ...and more!

00:00  Chart of the day
BSE Sensex will touch 40,800 levels three years down the line!

This statement did catch our attention and we are sure it definitely would have caught yours. But before any confusion is created, please note that this is not a prediction that we are making. It is a view that we came across, made by the private banking arm of a large bank.

With the BSE-Sensex hovering around levels of 24,400 points odd today, this would mean an index gain of over two-thirds. On a compounded basis the returns come up to a mouthwatering 20% on an annual basis.

With the Modi government getting the most decisive mandate since 1984, Indian stock markets have got the trigger they have been waiting for... and with this, we once again have fresh Sensex targets making rounds left, right and center.

'Sensex to double from current levels if the reforms come through.' is another headline we came across.

All said and done, one thing is certain: expectations are high. And the strange bit is that most of the changes in earnings estimates have been made in a matter of a few weeks - before the reforms expected to trigger and turn the cycle have been implemented in the first place. There have already been considerable amounts of re-ratings and revisions in earnings estimates by many.

But if one thinks about it, at the end of the day it all boils down to multiplying a forward multiple with the expected EPS figure to come up with a target for the index.

When it comes to the multiple, the figure taken by most institutions would be similar as they would be relying on past data to decipher the same. As we had highlighted in an issue recently, the long term 1-yr forward average multiple of the Sensex stands at 16.7 times.

As such, the predictions would largely differ due to the estimated future EPS figures of the index. As of date, the Sensex's EPS currently stands at just about Rs 1,360.

The table below indicates how sensitive the Sensex target would be with a 2.5% change in compounded annual growth rates.

Sensex targets vary mainly due to EPS growth estimates
g EPS estimates Sensex targets*
1-yr fwd 2-yr fwd 3-yr fwd 4-yr fwd 1-yr fwd 2-yr fwd 3-yr fwd
7.5% 1,462 1,572 1,690 1,816 26,247 28,215 30,331
10.0% 1,496 1,646 1,810 1,991 27,482 30,230 33,253
12.5% 1,530 1,721 1,936 2,178 28,745 32,338 36,380
15.0% 1,564 1,799 2,068 2,379 30,037 34,542 39,723
17.5% 1,598 1,878 2,206 2,592 31,357 36,844 43,292
Data Source: Equitymaster Research
* - at 16.7x one year forward earnings; g - earnings growth rates

As you can see, keeping the forward multiple of 16.7 times the same, Sensex targets will change as growth rates move higher.

As such, 'g' becomes a big factor to determine the same. And since the 'g' is expected to increase as the country's growth rates rise, it thus boils down to India's GDP growth rates.

To expect earnings growth rates to remain high over longer periods is a very aggressive approach in our view. Especially when one looks at things from the current point when there is a good amount of uncertainty all across.

In today's chart of the day we have shown the trend in Sensex earnings and the change in the country's GDP levels.

Sensex: EPS changes in tandem with GDP

While the trend seems to have been broken in the past two years, there's no denying that growth rates have slowed down substantially.

Nevertheless, if one takes an average of the change in earnings by the change in GDP over a decade, it comes to about two times.

The key take away from this chart would be for the earnings growth rate to be justified way above what they have been in recent years, a lot of measures would be required to boost the GDP back to desired levels. India continues to grapple with a host of issues and the scenario will not change overnight.

We had very recently highlighted concerns regarding the euphoria surrounding Indian stocks in current times as well.

While broad 'triggers' seem to be in place, the point of sticking with the best companies and buying stocks at decent valuations should not be compromised, we believe. Irrespective of which direction India's growth rates move - and the degree to which they change - good quality companies will deliver over long periods.

Has your broker been after you to make the most of the current market rally? Do share your experience. Let us know in the Equitymaster Club or share your comments below.

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How will brokerages and advisors justify their steep Sensex targets going ahead is anybody's guess. But what worries us is the fact that investors who buy into such claims could be in for a huge disappointment. And it will take just one big macroeconomic surprise to spoil the party! The risk of the US Fed raising interest rates too soon is already an overhang on global liquidity. The heavy FII inflows that are flooding Indian markets currently may retreat faster than they have come in such eventuality. To add to that, RBI governor Raghuram Rajan is already preparing to retaliate with monetary weapons. We have written earlier about how Rajan has not minced words about his disapproval of Bernanke's QE. As per Economic Times, this time around Dr Rajan has sent out a warning of sorts! One in which he has proposed that developing economies will not tolerate the developed world's easy money policies lying low. Instead they will take measures so that the cheap liquidity does not lead to yet another financial crisis. For this, he suggested, developing economies may intervene to keep their exchange rate down and build huge reserves. An act, which they might call, Quantitative External Easing or QEE. Whether Dr Rajan QEE will be able to fight off the risks emanating from the multiple QEs is anybody's guess. But investors have to be mindful of the fact that the road ahead for global macro economy, particularly that in India, is not going to be as smooth as is believed.

Now that Mr. Modi's Government has taken charge at the centre, new schemes are being planned. And in the process, some of the old ones are getting scrapped. One such scheme is Jawaharlal Nehru National Urban Renewal Mission (JNNURM), the UPA's flagship urban development program. Mr. Venkaih Naidu, who now heads Ministry of Urban Development, will replace JNNURM with a fresh scheme. The new scheme is quite ambitious with an aim to provide housing for all by the end of the decade by focusing on low interest rates. Further on Mr. Naidu's agenda is the creation of 100 smart cities with latest technology and infrastructure. With an outlay of Rs 1.5 lakh crore, the focus will be on spatial planning, waste management and better civic infrastructure. A key point to mention is the plan to clean pilgrimage cities to give much needed facelift to tourism industry in India.

These are some noble ideas indeed! However, even as curtains are drawn over almost a decade old JNNURM, we hope the new Government will spend some time to analyze as to why it failed. The old scheme that started with much fanfare could not live up to the expectations. As on date, around 50% of the projects planned under it are still pending. And hopes are of the new scheme not ending up in the same manner. Further, we would suggest investors not to get carried away with the ongoing announcements and to take a more realistic approach when selecting stocks.

With Mr Modi's election pitch largely centered around growth and development, the infrastructure space has once again come into the limelight. Little wonder then that infrastructure funds that were languishing since 2008 have now begun to record strong gains. Indeed, as per an article in the Mint, infrastructure focused funds have returned 35% over the past year, outperforming diversified equity funds, which returned 24%. The scenario was quite the opposite just a year back. At that time, the 1-year return by infrastructure funds stood at 9%, as against 22% from diversified equity schemes. Interestingly, most of this run up has largely been based on expectations than reality. No doubt Mr Modi has promised growth and development. As a result of which, there are hopes that key projects that have been stalled will now take off. But these policies still need to be implemented. And is not likely to happen overnight. Thus, we would caution our readers to not get carried away by this euphoria. Indeed, even the best infrastructure companies with strong fundamentals could currently be trading at expensive valuations. And this is something that our readers need to be mindful of when taking the decision to invest.

Here's a very good example of how things meander along in India. GST, the most radical of all tax reforms as per us, has been in the works since 2000. But it still hasn't seen the light of the day. And this is shocking given how its implementation could turbo-charge India's economic growth. The key impediment is its Federal structure that requires consensus building amongst states. So far, it was the BJP led states that were the principle adversaries of such a change. However, with their own party forming Government at the centre, we hope a lot of the objections should just vanish into thin air now. Or will it be the turn of the non-BJP ruled states to drag their feet on the issue this time around? Quite possible we reckon. Old habits don't die so easily after all. Even if the thing at stake happens to be a better economic future for the country!

Because euphoric markets are highly alluring, they generally tend to invite bubbles. Consider this for instance. Early this year the Wall Street had fallen for the marijuana stock bubble. Marijuana is 'Best Investment Theme for Next 10 Years'. This claim came from the CEO of the renowned financial news company at the start of this year. It was well debated that legalization of this drug will give rise to investment opportunities. But it gave rise to a penny stock market boom in the US. Of course the investors too fell prey to it. But then came the sad part! The bubble burst. Within five months, the Securities and Exchange Commission (SEC) rang the warning bells. On account of manipulative transactions and unlawful distribution of securities, SEC had to temporarily halt the trading of these penny stocks that had roared on account of boom in marijuana sector. Not only dud investors have their fingers burnt with the bubble going bust, but their investments too came under the regulatory scanner.

There are sufficient such learnings to drive the point back home. So let's not fall for the bait. Hence, remember what the legendary Paul Samuelson has to say."Investing should be more like watching paint dry or watching grass grow. If you want excitement, take US$ 800 and go to Las Vegas".

The Indian stock markets traded below the dotted line today. At the time of writing, the benchmark BSE-Sensex was down by 210 points (0.85%). Apart from pharma stocks most sectoral indices that were trading weak IT, Metal and Auto stocks were among the biggest losers on the bourses. Among Asian Indices, apart from Hong Kong most were trading in the green with Singapore leading the gainers. European markets have opened the day on a mixed note.

04:55  Today's investing mantra
"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks." - Warren Buffett
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3 Responses to "What Sensex level is your broker selling you?"

Gurdeep Singh Bariana

Jul 8, 2014

Am neither banker, nor trader of share. Started in share, just for fun, or to keep myself engaged. Now about trend. After long time or say post independence, we have government, which has to perform, or will be performing. Reason, the mandate which nation gave them, is given by the enlightened society. Nation is waking up,eg:"heard people telling, increase the fare, bur give us batter facilities" a very important factor. Earlier elections were on emotions, Nehruji, Indraji, or on conflict basis with neighbour. And so on. Past government, infact no government, was run on personal whim ( semi dictatorship ), to keep it going, there by getting blackmailed, by smaller or regional parties, which ruined, what good even they did, projects derailed and delayed. Now, elected members, knows, perform or get lost. Hem of the affair is very strong man. Keeping all the picture in mind, would fairly predict, stocks will perform, as predicted above.


M M Amalsadvala

May 29, 2014

Though I have a Broker which is a must for every Investor as without a Trading account one cannot invest in Shares, I am not dependant on the Broker to give any advice. Nor I will take such an advice unless I go into the depth of the financials for a scrip recommended. Levels do not have any boundaries - Ups or downs - it will always rollercoaster. From your pointed question - my question arises are Brokers really interested in the welfare of their clients?? I firmly say in the negative.
My earlier comments on Brokerage firms may please be looked into.

Like (1)

Kamal Garg

May 29, 2014

GDP growing at a nominal average rate of +15% has always been there for most part of the last 10 years and therefore translating the same into Sensex EPS also growing at +15% is also an accepted hypothesis. Sensex at 30000 in the next 1 to 2 years is a real possibility.

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