The Most Crucial Metric You Should Be Tracking - The 5 Minute WrapUp by Equitymaster
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The Most Crucial Metric You Should Be Tracking

Sep 19, 2016
In this issue:
» The much-awaited insurance IPO is finally here
» Market roundup
» ...and more!

00:00 Chart of the day

Richa Agarwal, Research analyst

The Nifty is hovering close to its lifetime high. With flush liquidity and optimism flooding the market, the question on everyone's mind is...

Are markets overheated? Should investors be worried?

Before branding the Nifty expensive, let's take a look at the P/E ratio. After all, index levels mean nothing unless seen in the context of underlying earnings.

Currently, the Nifty is trading at a PE of 24 times. This is not the first time it has traded at these valuations. Yet, on a trailing basis, it's at a five-year high.

Nifty PE at a Five-Year High

Are these valuations beyond our comfort zone?

Valuations, ideally, should consider future earnings growth rather than past performance.

Corporate earnings, as we have written before, are at an inflection point. As the chart below shows, FY16 profit margins touched decade lows. Keeping in mind the overall economic developments, we believe that a reversion is in order. It's difficult to pinpoint the exact turnaround quarter and quantum, but it would be safe to assume a 15% CAGR (historical rate) over the long term from the current levels.

Corporate Earnings at an Inflection Point?

With these assumptions, the implied three-year forward PE ratio comes at 15.8. The median historical three-year forward PE is 14.5 times. Keeping in mind all the structural and cyclical factors, we believe the valuations are reasonable, if not cheap.

Valuations - Reasonable, If Not Cheap


Even at current valuations, the market could offer good opportunity to earn double-digit returns. The key is to find stable companies where future earnings growth justifies the multiples they command.

As Tanushree says, businesses have a number of moving parts that decide growth: demand, pricing power, leverage, and most importantly, the industry capacity and specific utilization levels.

I find that quite interesting because most analysts are busy forecasting demand and don't give due importance to the supply side.

Tanushree, in fact, has analysed capex trends of India's 200 largest companies across different industries. And her conclusions are interesting: 50% of the incremental capex in the last ten years took place in FY13 and FY14. And just nine companies accounted for 50% of that.

Here's Tanushree in a previous edition of The 5 Minute WrapUp:

  • Since those nine companies are among the largest players in the sector, their capacity utilisation will determine the sector's growth and profitability over next three years. Weak demand for their products could be a drag for not just these players; it could negatively impact volumes and realizations for the entire industry.

    Therefore, the most important data point that I will be tracking is the capacity utilisation of companies that have recently added capacity. We will be wary of businesses in sectors that are more likely to face overcapacity in the next few years.

With this filter in place, the team has identified some blue-chip stocks that are well positioned to make the most of the index's upside over the long term. To know more about these stocks, check out our special report: Sensex 40,000: 4 Stocks to Profit from the Coming Stock Market Wave.

03:30

The much-awaited IPO of ICICI Prudential Life Insurance Company is finally here.

Going by the media reports, the consensus view on the IPO is positive. But before you fall for the numbers and ratios the media throws at you, bear in mind that this is the insurance industry. The implications of certain financial metrics can be entirely different from that of a conventional business. And that we have no pure play life insurance company listed in India compounds the valuation issue.

Insurance industry jargon, the lack of disclosures, and clarity on regulations don't help either. My colleague, Rohan, however, has kept the mumbo jumbo aside and dug deep into the actual business offering and whether it is worth subscribing to. To read our detailed IPO report on ICICI Prudential Life Insurance Company, click here.

04:30

The Indian stock market indices are trading in positive territory. Barring the FMCG index, all sectoral indices are trading on a positive note with stocks from the IT and metal sectors leading the gains.

The BSE Sensex is trading higher by 69 points (up 0.2%) and the NSE Nifty is trading higher 31 points (up 0.4%). The BSE Mid Cap and BSE Small Cap indices are trading higher by 0.5%.

04:50 Investing mantra

"Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Ankit Shah (Research Analyst).

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