Even as the Indian equity market is trading near its long-term average valuations, given the slowdown in corporate earnings in the past three years, the forward earnings multiple appears expensive compared to its median value for the period.
As per Bloomberg data, the Sensex is trading at one-year forward multiple of 15.2 times, which is 4% to 6% premium to its average multiple over the last three and five years, respectively. The ten-year average forward price-to-earnings multiple of the Sensex is 14.9 times.
As the corporate earnings started reflecting the slowdown in economic activity, analysts have argued whether lower valuation multiple may be the new normal for Indian equities.
This premise took a back seat last year, when the market was largely supported by the optimism around the general election and a subsequent clear majority won by the Bharatiya Janata Party. However, as the earnings numbers of India and looming analyst downgrades now are the key driver for market momentum, the Sensex may be looking at lower valuation multiple.
Recently, Kotak Institutional Equities argued that though the market appears reasonably valued with the Nifty trading at 15 times its expected earnings for FY17, valuations may start looking pricey once earnings estimates are cut further.
An earlier FE compilation shows that Sensex earnings grew nearly 2.5 times India’s annual GDP growth in the decade ending FY11. However, post that as the GDP growth slowed down to lower single digits, the earnings momentum has come off.
During the five years ended fiscal 2007-08, when India’s economy grew 8.7% per annum on an average, the earnings growth turned particularly strong at nearly 24% per year. However, in the subsequent four years ended FY12 when the mean GDP rate came down to 7.7%, average earnings growth stood at about 10%. Over these four years,the Sensex one-year forward P/E multiple stood at around 13 times compared to its average of about 15 times in the previous five years.