Sensex and Valuations

For this post, I assume that you know these terms : Earnings Per Share (EPS), Price/Earning Ratio (P/E) and Sensex. Also a disclaimer is required : This is just a possible guideline, not any prediction. So do not blindly follow up based on this post. “Take wise decisions”.

Now checkout following table :

FY	Sensex EPS	Sensex at P/E 15	Sensex at P/E 20
FY07	700	10500	14000
FY08E	825	12375	16500
FY09E	925	13875	18500

Note : FY08E – 'E' here indicates 'Estimated value'. This estimation is not done by me, but it's a consensus value available in different broker research reports. Also Sensex EPS means total EPS of companies represented by Sensex.

For Emerging markets (BRIC countries : Brazil, Russia, India, China),range of P/E ratio is 15 to 20. P/E ratio of 15 is on cheaper side and P/E ratio of 20 is expensive side. So you can say for FY08, good range of Sensex is between 12375-16500.

Now some mathematics. Today we have sensex at 14000 : almost near to expensive border with FY07 EPS. At the same time, if you calculate with EPS of FY08E, P/E comes to almost 14000/825 = 17. This P/E is called “Forward P/E” (Calculated with forward “next year”'s expected earnings – hope I am correct).

Point is : We are at the expensive valuation of Sensex. Even with forward P/E of 17, it looks expensive. Because Earnings of FY08 are still on paper, only estimated values. Q1 results are still 2 months away. So this indicates “avoid any type of buying new shares”. And if you are sitting on Profits, then it also indicates Selling (remember : Sell at high).

As per my Dad's logic and after seeing history of sensex, every year during May-June, market crashes. One common reason given by most of analysts (which I also found convincing) is : Major money invested in Indian Markets is by FIIs. FIIs must be keeping targets (like EPS estimation) for a financial year. After every quarterly result, they adjust their investment i.e. Churn/ Reshuffle their portfolio to invest in better companies. By the time forth quarter results (May-June) are out, they start booking their profits and so we have this “Sensex” crashing every May-June.

By the way, they (some reports) say that by FY2009-10, Indian MF industry will be bigger than FII. So one can expect less volatile movements of Sensex after then.

In general, this is just an indication of what range we can expect for Sensex during next year. Also as an investor, you should be tracking EPS of your company. Sensex is just representative of the overall market. It might be possible that your company might be doing better or worse than Sensex.

Read about buying guidelines here :
Buying a stock : Step 1
Buying a stock : Step 2