Observing Broad Market Valuation And Buying Selective Stocks- Is It Prudent?

Observing Broad Market Valuation And Buying Selective Stocks- Is It Prudent?

(Study has been done mostly on Mcap weighted average-however the method of calculation has been consistent throughout)

When we say currently Sensex Forward PE (FY09E) is at 17x (Free Float weighted) and 20x (MCap weighted) and then compare it with last 12 months average forward PE and we deduce that market is cheaper and now we can buy GOOD STOCKS (within Sensex).

Stocks like Reliance Ind, ICICI Bank, HDFC twins, L&T and likes- Which have a consensus or Mostly Buy ratings from prominent research houses (domestic and international alike) are good buys. And we avoid stocks from cement, auto, IT (though INR depreciation has brought back interest-nevertheless could be short lived!)-these sectors have cautious (Hold/ Sell) view from the same prominent research houses. Then there are few stocks on which the views are mixed like Bharti, BHEL, SBI etc.

Then I thought market is looking cheap land lets look into stocks that fall into Consensus/ Mostly Buy category. I started looking into their valuations. I looked into their PE, PBV and earnings growth and ROE etc. On Forward PE, these stocks trade at around 16% premium to Sensex (MCap weighted Forward PE) with similar earnings growth expectation of around 13-14% Y-o-Y. On Forward P/BV, these stocks trade at 12% Discount to Sensex but expected to generate an ROE which is 16% inferior to MCap weighted Sensex ROE!





I did the same exercise on the stocks that are in cautious category (either Hold/ Sell). On forward PE, these stocks trade at a discount of 19% with FY09E EPS growth expectation of 11% against 13.5% of Sensex. On Forward P/BV, they trade at 13% premium to Sensex P/BV but with generate an ROE which is 20% better than Sensex.



Hence, if we say that broad market valuation is at 12-15 months lows and its time to buy stocks, should we buy selective stocks or should we buy market (typically an ETF)? We say that market is at 17x and we buy stocks with PE of 20-25x (that contains some stocks that were valued cheaply when market was more valued than today).

(There could be an argument that the BUY rated stocks continue to trade at premium, agreed but the stocks which are on consensus/ mostly BUY list changes-Ratings are not Static. And when Mr Market was at 20-25x earlier there were another set of stocks which were on Consensus Buy lists Like NTPC, Reliance Energy etc. and people were not so sanguine about Ranbaxy, ITC and DLF- I was considered as risky investor when I applied for DLF IPO for my company!)

Food Price Inflation: Is it slated to clam down?

Essential food prices had sky rocketed between Nov 2007 and March 2008. During this period, Wheat, Rice, Sugar etc rallied the most in the past decade. We had many articles suddenly appearing in business dailies regarding shortage of essential food. Supply situation “WORST IN 3 DECADES”- Because of:

 Stagnant productivity
 Consistent rise in demand
 More stress on bio fuels
 Shift of agricultural land toward the production of Bio-Fuels, etc.

International money managers give these reasons whenever they meet us, presenting some structured product deal with commodity as underlying.

But these phenomenons were there for quite many years. Then why suddenly money managers found these reasons to shoot up the prices of these commodities too fast?

To my understanding, the sharp jump in commodity prices was less to do with the mentioned fundamental factors and more to do with liquidity shift from equities/ credit/ structured products to essential commodities. Gold, Oil, Wheat, Rice-all went up sharply in the past 6 months. Money flow in commodities was the highest by retail as well as the institutional investors during this period.

However, April was (rather surprisingly) very good month for credit and equity markets. There was a feeling that the worst is behind us! Money chased these markets on the back of improved sentiments and resultantly food prices fell sharply during Mid-March-April end.

Gold, Wheat, Rice, Sugar-All fell sharply during this period. However, Rice again shot up quite fast in the past 3-4 days due to Myanmar factor (its rice field was destroyed). Oil is at record high, because of strong fundamental reason.

Hence, if this relation is something to go by, we can see some easing on the food inflation front going ahead! However May again can bring the credit devil back to the market and these commodities can again rise (and consequently short term food prices led inflation), but hard to touch their recent highs.

See related charts below...

S&P (Jan 2007- May 2008)



Wheat (Jan 2007- May 2008)



Raw Rice (Last 12 Months)


Sugar (Jan 2007- May 2008)



Gold (Jan 2007- May 2008)