Overvalued Opinion is divided, but debate rages on

Updated: Oct 31 2006, 05:30am hrs
After breaching the 13,000 points mark in a matter of 182 days since February 7th when the Sensex reached the five-figure mark, the question all around is is the market overvalued

The indicators definitely point towards a heated situation. One of the key indicators, the market capitalisation to GDP ratio, is now nearly 100%. According to a school of thought, a move over the 100% zone means that the market is overvalued.

Then the trailing price to earnings (P/E) ratio of around 21 times the FY2006 earnings is in the unsafe zone as other markets are at around 13 times the earnings. The P/E ratio is much above the 15 year median of 16 times. Sensex stocks are now 4.90 times their book value. Prudent analysts suggest that a price twice the book value is a fair valuation for the business.

However, market denizen remain optimistic. I would say the market is definitely not undervalued. And at the same time, I will not sell the market, says Sandeep Neema, fund manager with JM Financial Mutual Fund. Others also reckon that indicators should be seen in the right context.

They reasoning is that the market looks to future earnings and if the earnings trend continues, FY07 will see a tremendous growth and even a subdued FY08 means the forward P/E is around 15 to 16 times. This is reasonable.

As regards the P/BV (price to book value), it should be seen in the light of the Return on Equity. For FY06, the RoE was around 23.5%, and this is a good 8 percentage points higher than the median of 17%. Hence, a higher P/BV is justified. The RoE is expected to be higher in the next year as the results would be better.

A fund manager scoffs at the market capitalisation to GDP ratio and considers its interpretation as out of context. The reasoning here is that the GDP figures reported in India are not completely representative. It does not consider the parallel economy which is considered to be the same as the reported GDP, if not more. Another point is that the US markets have seen many years where the market capitalisation was more than the GDP.

The consensus, however, remains that the market is precariously perched. "At these levels, markets will be volatile and investors should have the nerves to stay calm during volatile times and focus on the long term story," says R Venkatraman, executive director, India Infoline.

With the credit policy slated to be announced Tuesday, there is more action expected on the stock market in the days to come. The ride, however, will definitely not be for the weak hearted.