The NSE Nifty generated a return of 54 per cent in 2007, while earnings growth for Nifty companies was closer to the 30 per cent mark. In simple terms, this means the Indian market got rerated upwards in 2007, ie it’s PE multiple expanded. Assuming that the Sensex eps would work out to around 870 in FY2008 and closer to 1040 in FY09, the Sensex closed 2007 at a PE of 23 on FY08 earnings and just under 20 times expected FY09 earnings. The billion dollar question: is there case for further rerating in 2008?
A wide-ranging poll of investment banks conducted by CNBC TV18 shows that a majority expect the Sensex to end 2008 between 22000 and 24000. The midpoint of this range implies a 15 per cent increase over last year, much more modest than the 50 per cent we saw in 2007. Let's be a bit more optimistic and take 24,000 as the consensus bull scenario. That would work out to a PE of 23 times 2009 earnings; in other words the market would then have held it's current valuation level assuming that earnings grow by 20 per cent this year. Any level higher than 24,000 would imply continued upward rerating. While most experts consider it unlikely, it could certainly happen if earnings growth surprises with a higher than 20 per cent number or if a lot of liquidity chases Indian paper, as it did in 2007. Also, while a one year forward PE of 20 is by no means inexpensive, it is not quite the wildest valuation multiple which has been seen in earlier euphoric bull market tops. The question to ask then is whether 2008 is going to be a year of renewed emerging market optimism aided by more rate cuts in the US. If the answer to that, despite US economic problems, is yes , then higher valuation levels are certainly possible. Market levels, after all, are not determined by textbook led experiments conducted in vacuum; rather by a rather complex chemistry of fad, sentiment, perception, ownership, liquidity and fundamental value.
The other thing to recognise is that the environment changes; often in ways which are entirely unpredictable at the start of any year. Who knows, by the end of 2008, the interest rate scenario might have changed completely, leading to a revaluation of all interest rate sensitive sectors. Ditto with the currency and infotech stocks. Short point, predictions made today are in an “all things being equal” scenario, which is rarely the case in stock markets. Be prepared for surprises, that's about the only thing that one can predict with some certainty.