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Valuation story

May 30, 2003

It has been an upward trend for the stock markets over the last two months. This time the buying interest is not just in the banking sector alone, but also in other sectors like cement, refineries and engineering. With the US markets also firming up, technology majors have also looked up in the recent past.As far as the rally in the banking sector is concerned, as we have maintained throughout this phase, optimism seems to be overplayed at the current juncture. This holds true atleast for some PSU banks that have a poor track record and a pile of non-performing assets. If one were adjust for the same from the net worth of the respective bank, the price to book value multiple is on the higher side. The reason for the optimism is three fold. One is the possibility of return of capital by PSU banks to the goverment. Secondly, the passing of the securitisation bill and lastly, the government bond buyback plan.

Though one agrees to the fact that these measures are likely to have a positive impact on the banking sector over the long-term, it is wise to exercise caution. Having said that, considering the malaise in the global banking sector, especially when one hears of the trend in countries like Japan, it is safe to say that India's banking sector is far more efficient at the current juncture. But there is a price for all the efficiency and expected change in the profit profile. Obviously, PSU banking majors have seen a correction in valuations (against the historic trend of 1x adjusted book value, the current range is an estimated 1.5x). But it does not hold true for all the companies. Like any other sector, there are industry leaders who set trends and there are laggards. This differentiation is important from the risk-return perspective. Investor's should exercise caution and there is no point blaming the market for losses.

Beyond the banking sector, the FY03 results so far have been an impressive one for India Inc. Both at the working capital and at the debt level, the top rung listed manufacturing companies have come a long way. This has been combined with an improvement in productivity as well. Some of them are now looking beyond India, which we expect could be profitable over the long term. Despite these the Sensex is trading at 11.7x trailing twelve months earnings. But as is said often, valuations correct to fundamentals over the long-term and it is time investor's build their portfolio.


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