Thursday, July 10, 2008

Sensex will not cross previous highs till 2015

Everybody is talking about when the Sensex will bottom and when it will start its previous march towards new high. I want to differ and stick my neck out to say that Sensex will not cross its previous highs till 2015. I will put my own analysis. All the march quarter results for Sensex companies are out. The Sensex closed at 13,926.24 with P/E shown here 17.24. That makes an EPS of 807.78.

Sensex was trading at 3386.89 in 2003 June with an average P/E of 14.61. Thus EPS in June 2003 was 231.82. In the last 5 years Sensex earnings have gone up by almost 3.48 times i.e. 28.36% compounded annually. Some of these contributions were from cyclical commodity businesses like Cement (Ambuja Cement, ACC, Grasim), Metals (Tata Steel, Hindalco), Power/Infrastructure (BHEL, L&T, Rel Infra, NTPC, Jaiprakash Associates, DLF) and Oil and Gas (ONGC, RIL). Some of the earnings were from slowing sectors like Auto (Tata Motors, Maruti Suzuki, Mahindra & Mahindra), Pharma (Ranbaxy, Cipla), FMCG (HUL, ITC) and Tech (Infosys, Satyam, Wipro and TCS). The biggest contributions were from fast growing businesses of Finance (HDFC, ICICI, HDFC, SBI) and Telecom (Reliance Communications, BHARTI). Cipla and Ambuja Cements are going to be replaced by Sterlite and Tata Power.

What my gut feeling is that Cement, Metals, Auto and Infrastructure will see only 7% compounded annually increase in their profits in next 7 years till 2015 (equivalent to inflation).

Oil and Gas will increase their profits at 15%.

Pharma, Telecom, Financials and FMCG will be able to increase their profits by 12% for the next 7 years (counting equity dilution for financials).

IT will increase its profits by 15% till 2010 but then higher taxation and wage will erode their profit margins so they will also increase profits 7% compounded annually (equivalent to inflation).

Now if we consider the weight of these sectors in Sensex,
Auto (2.91), Cement (2.58), Metals (5.09) and Power/Infrastructure (15.7) makes 26.28%
Oil and Gas makes 19.37%
Pharma (2.57), Telecom (8.47), Financials (20.09) and FMCG (7.39) makes 38.52%
IT makes 15.83%

Now if Sensex's 26.28+15.83=42.11% grows at 7%, 19.37% grows at 15% and 38.52% grows at 12%, the whole Sensex will grow at 10.75% and achieve an EPS of 1650 in 2015. At 14 times 1650 comes 23104.

There are many ifs and buts here. Growth rate may be very very wrong. New comers to Sensex (Sterlite and Tata Power) may make huge jumps in profits due to increase in commodity prices or power reforms carried out by government, and so on.

Last time when Sensex touched 21207 on 8 January 2008, the market capitalization of the BSE was 75 lac crore. Indian economy is today at 44 lac crore and if it grows by 8% for the next 7 years, the economy will become 75 lac crore. Generally, stocks are fairly priced when GDP equals total market capitalization of stock exchanges.

Let's see.
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