Markets: How bad can it get?

by Ajay Jindal/ ETBB

The ferocity of the fall has caught most investors by surprise. The market fell around 24% in 20 trading days. On Friday, there was some recovery, but perhaps it is best to look at an extreme scenario — assuming a lot of bad news does turn out to be true, how low can the market go? For this purpose, normal discounting range of the market is an important factor to look at. Let’s reproduce a table (‘Sensex Forward P/Es’)
ET Big Bucks has used in the past to explain market discounting. The BSE sensex has normally traded between 11 and 14 times one-year forward P/Es. This range was breached during April-May ’06. In April ’06, the market was trading at 17 times forward. This touched 19.6 times forward on 10 May ’06. This may be one reason which may explain the selling which followed, though it was clearly more vicious than anyone imagined. Let’s use this metric to see what can possibly be the worst-case scenario one year from now. The sensex’s price-earnings ratio is currently around 16.5, giving it an EPS of Rs 566. Assuming a 15% earnings growth (though some firms are now assuming it to be even lower), the EPS for FY07 will be Rs 650. Assuming a 15% growth for FY08, the EPS for the sensex will be Rs 750 two years from now. Assuming that the market will quote at 11 times forward within a year, the sensex could touch around 8250 one year from now. This is just a rough number, based on assumptions of growth rate and market P/E. The Indian market has traded at P/Es like 8-9 because India is a growth economy. The overall growth story is still intact for the time being, and there are no expectations of any drastic slowdown. So, for an economy which grows at 12% in nominal terms overall, an 11 times forward P/E is a very low P/E. Sensex companies, which are India’s largest and best companies, will be typically expected to grow faster. If we look at the data for the past five years, the net profit of sensex companies has grown by around 20% or more every single year, including FY01 and FY02, which were quite bad years for the rest of the economy. This still begs the question of where should the market be now. The expected sensex EPS for FY07 is Rs 650. At current levels, the market is quoting at around 14.5 times forward.
If investors feel, the market should quote at say 12 times forward, then the market should come down to 7800 levels. So, the bottom is somewhere around 8000 levels. This is quite a way down from where the sensex is right now. Hopefully, the worst will not come to pass and the market will not go there. However, it’s best for investors to be on their guard for a few more days to assess this.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s