Strong underlying growth and a series of earnings upgrades has resulted in a 74% return in the BSE Sensex during FY06. As the Indian stock markets have continued their upward march, delivering 20% return during 4QFY06 and 74% return during FY06, the Sensex is already at the top end of our revised 12-month target range of 9,600-11,800. We believe that at current levels, the markets are fairly valued and recommend buying stocks that offer secular growth at reasonable premium.
While the long-term India story remains intact…
The longer-term India story remains intact. The economy is expected to enter the fourth consecutive year of 7-8% GDP growth, which is unprecedented. Strong balance sheets of Indian companies, rapid scale-up to global size through organic and inorganic initiatives, visibility of earnings CAGR of 15% over next few years, and high standards of transparency and corporate governance will ensure increased allocation to Indian equities. We expect investors to make healthy returns, provided the investment horizon is longterm. … the Indian stock markets are now fairly valued
While the long-term India story continues to be positive, we would like to underscore that the markets are now trading at the higher end of our target Sensex band. On several parameters, market valuations are now above historical averages and leave little margin of safety in the event of any disappointment in corporate profit growth. However, valuations are still well below the levels witnessed at the height of the previous bull runs.
While the markets appear fairly valued, they are still far from the bubble valuations witnessed during the previous bull runs. The current momentum of strong inflows from both domestic and foreign investors will be the most important determinant of the near term market performance.
Buy secular growth at reasonable premium
We note that the valuation premiums of some secular growth sectors have contracted and there is an opportunity to buy growth at relatively lower premium. We would classify large cap IT, wireless, private-sector banks, and two-wheelers in this category. We believe that such sectors/stocks offer a better risk-reward trade-off and the current market expectations on these companies are in sync with their past financial performance.
Our preferred bets are Bharti, Infosys, SBI, HDFC Bank, Hero Honda and Maruti.
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