Thursday, June 4, 2009

Let's discuss P/E - Part 2

Extending Part 1 of this post, I would like to discuss P/E ratios of S&P CNX 500 instead of S&P CNX Nifty, the reason being P/E, P/B and Dividend Yield data for Nifty is available only till 1 January 1999 but similar data for CNX 500 is available till as far as 1 January 1996. This makes averaging of P/E etc. for five years possible during the bear market of 2001-2002. CNX Nifty 500 earnings on 1 July of each year between 1996 till 2002 was 59.2, 53, 51.2, 51.95, 41.3, 47.22 and 57.07. Thus the EPS didn't grow at all between 1996 and 2002 and the CNX 500 was trading at 775 on 1 July 2002, the same as on 1 July 1996.

Because of this discouraging performance by India Inc., shares were thrown away by investors for prices not reflecting the true potential of companies with CNX 500 on 1 July 2002 trading at 775 with a P/E of 13.55 and P/E of five year average EPS of 15.75. In September of 2001, when CNX 500 touched 545.85, the P/E ratio was 11.58 and P/E of five year average EPS was at 10.9, i.e. average EPS of five years was higher than the EPS of last year. The last time CNX 500 had reached 545 was in December 1996, five years without any returns.

Let's compare this with the recent data of July 2007 - March 2009. On 1 July 2007, the EPS of CNX 500 was 191.25, 3.22 times 59.3 of 1 July 2002 but CNX 500 was at 3630, 4.68 times 775 of 1 July 2002. This shows that 45% of the returns were due to P/E expansion and not because of earnings. The biggest worry was that due to earnings rising very fast, the five year average EPS was just 108 and P/E of five year average EPS was 33.6, more than thrice that of 1 July 2002. This shows how much investors were overpaying for growth.

Now compare the scenario of March 2009. EPS of CNX 500 is at 175 with average EPS of five years at 155 and CNX 500 at 2000, i.e. P/E of 11.42 with P/E of five year average EPS at 12.9. The recent rally might be taking people by surprise but the valuations do justify it based on P/E. Even P/B and Dividend Yield were similar to the bear market of 2001-2002.

Now compare this with current valuations. EPS of CNX 500 is at 188 with average EPS of five years at 159 and CNX 500 at 3650, i.e/ P/E of 19.4 and P/E of five year average EPS at 22.95, not very cheap but not very expensive either if compared with the valuations in January 2008 when P/E was at 27 and P/E of five year average EPS at 44.
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