What the Sensex at a Life High is Not Telling You About 2020

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  • Dec 19, 2019 - What the Sensex at a Life High is Not Telling You About 2020

What the Sensex at a Life High is Not Telling You About 2020 podcast

Dec 19, 2019

Tanushree Banerjee explains why the Sensex PE as a valuation metric, a bad market indicator.

She also reveals the right metric to use and you'll see immediately, what the earnings really say about the stock market.

Tune in to find out.

Here's more on Rebirth of India:

The growth in earnings i.e. profits, is the key to a rising stock market. When you buy a stock, you are buying the company's stream of earnings in the future.

If the earnings don't grow, or if the market's perception of earnings doesn't change, a stock won't rise.

Isn't that the logical thinking for someone trying to assess the stock markets? It certainly is.

But lately, you've probably heard a lot of worries about slowing earnings growth. If you follow the recent economic numbers, they are extremely disappointing too. Everyone's wondering if the bull market could stall due to this.

But today, I'll show you why the most widely accepted market valuation metric...the Sensex PE - something that Dalal Street analysts and money managers track so closely - is a bad market indicator.

More importantly, when you use the right metrics, you'll see immediately, what the earnings really say about the stock market.

Earnings growth should move closely in line with stock prices but in recent years, that's not what's been happening.

So, the fear that poor earnings growth could be a drag on Indian stocks and could halt the rally is hardly exaggerated.

The initial euphoria of the corporate tax rate cut boosting earnings has waned. But recent IPOs have shown that market is flush with liquidity. And the Sensex just hit a new all-time high. So, most investors believe that 2020 could begin with the bursting of the big bubble in Indian stocks.

The fact is that earnings growth comes with a lag. In some sectors earnings are cyclical. In others there is a strong correlation with investment in infrastructure activities, capacity utilization.

Now over the past decade, most of the Sensex stocks, quite a few of which are consumption related stocks have done fairly well in their earnings performance. Naturally their valuations too have surged. But slow economic particularly manufacturing activity has failed to lift the earnings of most non-Sensex bluechips. And over time, this earnings gap has led to a huge valuation gap between the Sensex stocks and non-Sensex bluechips.

So, say an Asian Paints or HUL was valued at 40 times earnings 5 years back...they are valued about 60 times now. Of course, these companies have been pretty consistent with the earnings performance. But can their valuations sustain?

To answer that and consider what could happen in 2020 let's look at this chart. It shows the growth in networth and market capitalisation of Sensex and non-Sensex bluechips over the past decade. The reason I have taken networth instead of earnings growth is to avoid the impact of cyclicality. And what you can see is that while the Sensex is fairly valued the non-Sensex bluechips have a fairly good upside in the valuations.

Which means....2020 could be very different from what most investors expect. And here is what the Sensex all time high is NOT telling you.

A bulk of the upside in 2019 has come on the back of a handful of 8-10 stocks.

So, it is quite possible that a temporary pullback in liquidity could lead to a correction in Sensex stocks. Especially with big IPOs lined up in the early months of the year, liquidity suck up cannot be ruled out.

But more importantly, the non-Sensex bluechip stocks could bring in surprises. By non-Sensex bluechips I mean stocks that are part of the BSE 200 index but not in the Sensex. These are the stocks that could enjoy a fairly long runway of growth in earnings and book value. And the upside in their valuations could be substantially larger.

So instead of being too focused on what the Sensex has to say, I would recommend looking for safer and consistent bets outside the Sensex.

To know more on this, please subscribe to The 5 Minute WrapUp.

Thank you.

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and Forever Stocks. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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1 Responses to "What the Sensex at a Life High is Not Telling You About 2020"

Sekar Sangeetham

Feb 2, 2020

I think in the long term it is the earnings growth that will determine the stock price.
(whereas your statement -Earnings growth should move closely in line with stock prices but in recent years, that's not what's been happening). so i would put it as Stock prices should move closely with earnings growth- isn't it?
I agree with the analysis that while sensex earnings growth (Networth) and MC growth are almost the same, but for Non Sensex stocks, there is wide gap in them meaning the non sensex stocks prices are undervalued, which you recommend to utilise by investing in them.
Good article.

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