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Theories do not always hold good on D-Street

This article was posted on Apr 27, 2009 and is filed under Market Outlook

NEW DELHI: Indian stock market may have corrected over 40% from its peak, but a number of stocks
are still deriving valuations that are either expensive or crazy in some cases. As many as 158 companies are trading at a premium compared to the BSE benchmark index, Sensex where investors are willing to pay exorbitant prices to buy them, a SundayET analysis of 447 BSE companies with minimum market capitalisation of Rs 500 crore reveals.

The market P/E is currently around 15, and logically a stock P/E should hover around the same levels. However, there can be some stocks which can trade at high P/E multiples based on their growth potential. But a P/E of more than 50 indicates unrealistic valuations.

Capital market experts say low liquidity, punter participation, high quality of investors and management, growth-oriented business models and consistency in business earnings are some of the reasons for these scrips fetching unusually high valuations in the market.

Leading the pack with a P/E of over 1,000 times are Sterling International Enterprises, a Mumbai-based IT firm, Mavens Biotech, a Kolkata-based biotechnology company, Hindustan Copper, Indian’s third largest copper producer and Orissa Sponge Iron & Steel, a Bhubaneswar-based steel firm. In fact, some 34 stocks are trading at 50 times their earnings, which indicates that valuations are not that reasonable in the Indian equity market.
To compare and assess valuation, we have calculated the price-to-earnings (P/E) ratio of these scrips and stacked it up against the average market P/E. The P/E is simply the ratio of the price per share to earnings per share. Suppose the rate of interest on a bank fixed deposit is 8%. You get Rs 8 by investing Rs 100 — you pay 12.5 times the earning for this asset.

In the case of a company, if you expect the company to grow well, and turn in capital gains, you would be willing to buy that company’s earnings that come with each share at a price higher than what you would fork out to get a bank FD that gives you a fixed rate of interest.

Crude oil prices may have slipped to one-third from its peak of $146 per barrel, but investors are still bullish on the prospects of up stream company, Cairn India. It is trading at a PE above 600. Interestingly, Fortis Healthcare, a company promoted by erstwhile promoters of Ranbaxy Laboratories, which had posted losses in the last three quarters is again a favourite among investors. It derives a valuation of over 450 times its earnings.

Motilal Oswal, CMD of Mumbai-based Motilal Oswal Financial Services say one of the reasons for absurd valuations is some of these companies operate in high growth businesses. “Then there are some cases where some of the companies have hidden assets which also results in high P/E ratios,” he says.

Other stocks on the same queue include Radico Khaitan (221 times), G M R Infrastructure (173 times), RNRL (140 times), Reliance Power (100 times), GVK Power & Infrastructure (72 times) and Indiabulls Real Estate (70 times). CJ George, MD of Geojit Financial Services says although the earnings are low resulting in a high PE, a number of these companies possess a very high cash-in-hand almost equivalent to their m-cap. “That’s why investors are not hesitating to take a huge exposure,” he feels.

However, there are some sceptics too. Sunil Sinha, senior economist at Crisil, doesn’t rule out the possibility of manipulators artificially inflating the market prices of these scrips. “It’s true that in some cases investors perceive high earnings potential but punters also play a role in others,” he says.

Theories have been proven wrong in the past, but it seems right now the valuation game is not going to slow down in a hurry!

source: Economictimes

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