I was way early

On May 7, 2010; I had made a macro call on financial sector in India. Let's compare the results today after three years and four months. BSE BANKEX was trading at 10505.86 at that time while SENSEX was at 16769.11. Today SENSEX ended at 18234.66 while BSE BANKEX ended at 9871.35. That means during the last three years and four months SENSEX gained 8.74% while BSE BANKEX lost 6.04%, an underperformance of around 14.78%.

It is still too early and biased to consider myself vindicated since BSE BANKEX has crashed just recently. I had also warned about an impending banking crisis in India in September 2010 although it was too early. Being early is sometimes no different than being wrong.

Sensex Nifty EPS after FY11 results

It seems all the results are out and the Sensex EPS as of 6 June stands at 18420.11/19.58=940.76. The Nifty EPS stands at 5532.05/20.43=270.78. This compares with 828.5 on 27 May 2010 for Sensex, i.e. an increase of 13.55% YoY and 239.4 for Nifty, i.e. 13.1% increase YoY.

Sensex EPS drops after SBI results

I had tried to give an early indication of Sensex EPS for the year 2011 in an earlier post. I had assumed that since around 46% of the companies; that are part of the Sensex; had announced results that increased EPS by 12.6% YoY, there will be some more gains in EPS when all the companies finish reporting their results. Today SBI announced their horrible results for the year ended March 2011 and the Sensex EPS; which was prevailing at somewhere around 933 (18345.03/19.66) yesterday; dropped to 924 (18137.35/19.63) today. Nifty still does not seem to be reflecting it. This result was before the interest rate hikes of 25 bps of January 2011 and 50 bps of May 2011 since the bad loans take at least 90 days/three months to come into banks' books. God help those analysts predicting an EPS of 1200 or more for FY12 (1100 for FY11 by Rakesh J, 1070 for FY11 by Motilal Oswal, 1250 for FY12 by Raamdeo, 1345 by UBS and 1100 for FY11 and 1250 for FY12 by Credit Suisse). Those who are finding PSU banks cheap on P/B or P/E basis need to rethink about the correctness of the results being published by UBI, Bank of Baroda, PNB, Canara Bank, IOB, Indian Bank, Allahabad Bank, Central Bank of India and Andhra Bank. I had already written about a coming banking crisis in India in September 2010 and I still stick to it.

How great companies outperform index over time?

Many a times so called analysts mark companies in FMCG and Pharma sectors as defensive. But if we look at the returns generated by these companies over long term, they are many a times much better than the returns generated from index. Today, I will describe two good companies from FMCG sector which have shown the same kind of characteristics over the last 10 years. The first is Nestle and the other one is Glaxosmithkline Consumer Healthcare. If you look at the returns generated by these companies over the last ten years, they can be summarized as shown in the following table:

* Average price

Company	Price 2002-03	Price 2007	Price 2011
Sensex	3000	18000	19000
Nestle	500	1100	3500
Glaxo Consumer	250	550	2200

You can see that during the bull market till 2007, both the companies underperfomed the Sensex by a hugh margin but after 3 more years, they are now outperforming the index. The Sensex generated returns of more than 40% compounded annually between 2002-03 and 2007 and many of the stocks like L&T, Reliance and BHEL went up by more than 25 to 50 times. The returns generated from both these stocks were of the order of 15-20% at best during those times. But the situation has changed over the last three years, all the stocks that generated great returns earlier are still trading 30-40% below their 2007 peak while these companies multiplied their returns and generated more than 40% returns compounded annually during the last three and a half years while the Sensex hasn't moved much. It is just in hindsight that somebody would have bought L&T and Reliance in 2003, sold them in 2007 and bought Nestle and Glaxo from that money. But buying good companies at great prices never turns out to be a bad deal.
Image: renjith krishnan / FreeDigitalPhotos.net

Where will Sensex EPS be after FY11 results?

Following table shows the list of companies that have already announced their FY11 results along with their weightage in Sensex as of May 3, 2011.

Company	Weightage
Reliance	11.45
Infosys	9.58
ICICI Bank	8.29
HDFC Bank	5.61
TCS	4.5
Wipro	1.81
Jindal Steel	1.8
Sterlite	1.79
Maruti	1.24

In total, 46.07% of the companies have announced their results so far and the Sensex value and P/E stands at 18534.69 and 19.87 respectively resulting into an EPS of 932.8. This compares with Sensex EPS of 828.5 on May 27, 2010. Thus, the Sensex EPS has increased by 12.6% over the last one year with 54% of the results still pending to be released, this at a time when the nominal economy is growing at a rate of 20%+ with 8% real GDP and 12% inflation. Not a pretty picture!!!

Image: jscreationzs / FreeDigitalPhotos.net

Sensex Nifty preliminary EPS after Q3FY11

While there are some companies, like Tata Steel, Tata Motors, M&M and Unitech still left to announce their Q3FY11 numbers, the preliminary EPS for Sensex and Nifty can still be calculated. Sensex ended at 18008.15 with a P/E of 19.78 which gives Sensex EPS of 910.42. The Nifty ended at 5395.75 with a P/E of 20.67 which gives Nifty EPS of 261.05. This compares with Sensex EPS of 876.36 and Nifty EPS of 250.62 at the end of Q2FY11 and Sensex EPS of 806.81 and Nifty EPS of 232.5 at the end of Q3FY10.Thus Sensex EPS has grown by 12.84% compared to last year while Nifty EPS has grown by 12.28%. This too in a year when the whole economy grew by more than 20% in nominal (inflation 12% + real 8%) terms. Now try to think how the EPS would grow to 1250 in five quarters, i.e. 28.86% compounded annually? If it cannot, then ask samir arora why he thinks Sensex is trading at 14.5-15 times FY12 earnings?

Image: renjith krishnan / FreeDigitalPhotos.net

Sensex Nifty EPS after Q2FY11

Sensex ended at 19691.84 on 23rd November with P/E at 22.47. This gives Sensex EPS of 876.36. Nifty ended at 6010 on 22nd November with P/E at 23.98. This gives Nifty EPS of 250.62. This compares with Sensex EPS of 781.98 and Nifty EPS of 230.38 after Q2FY10. Thus Sensex EPS has increased by 12.07% and Nifty EPS by 8.78%. If the first two quarter numbers are anything to go by, the Sensex EPS at the end of FY11 should be 12% higher than last year's 828.5, i.e. somewhere around 930 and Nifty EPS should be 8.78% higher than last year's 239.64, i.e. around 260. Compare this with analyst's estimates of 1100 by Rakesh J, Motilal Oswal and Credit Suisse. This requires EPS growth of 25.52% in just two quarters, i.e. 51% compounded annually. All the best to analysts.

It is contrary to human nature for investors to take extreme precautions against future collapse when current conditions make for optimism. - Benjamin Graham

Sensex - Nifty EPS - almost flat

It seems that quarter after quarter, I am providing the same post again and again. I had talked about Sensex-Nifty EPS not increasing in my last post.The same thing is being repeated after this quarter results too. Sensex EPS today stands at 18217.44/21.62=842.62 and Nifty EPS at 5467.85/23.07=237.01. This compares with 828.5 for Sensex EPS and 239.64 for Nifty EPS reported on 29 May. Sensex EPS has grown by 1.7% in the quarter, i.e. 6.5% annualized and Nifty EPS has contracted by 1.1%, i.e. 4.4% annualized. Be cautious!!!!

Sensex Nifty EPS not increasing

I had provided an early indication of what Sensex and Nifty EPS would look like after this quarter results in the article on May 1. The situation has not improved at all since then. Low P/E Grasim was replaced by high P/E JSPL in Sensex on 26 May and so the latest Sensex EPS has come in at 16387.84/19.78=828.5. The Nifty EPS is holding at 4917.4/20.52=239.64. So since our last update, the Sensex EPS has gone down by 2.375% and Nifty EPS has gone up by 1.2%. Not very pretty. Have some negatives like higher tax rate and dilution and the Sensex 16.5K and Nifty 5K does not hold a good picture. Be cautious!!!!

Macro Call

There are very few times when a value investor is able to make a macro call. But I am daring to do it at this stage. The call is on financial sector in India. If you look at Index composition of Nifty and Sensex, there is hardly any diversification left. Financial sector represents 23.74% of Sensex (ICICI Bank, HDFC, HDFC Bank and SBI) and 25.37% of Nifty (AXIS BANK, HDFC BANK, HDFC, ICICI BANK, IDFC, KOTAK BANK, PNB, RELIANCE CAPITAL, SBI). As all of you must be knowing, a value investor generally does not invest in financial firms since they are difficult to evaluate. This leaves just 76.24% of Sensex for investment for a value investor like me.

It has already been observed many a times in the past that when a particular sector garners most of the weightage of a financial index, it underperfoms the index. The evidence can be seen in IT sector after 2000 and FMCG and Pharma in India after 2003. So I am taking a call on Indian Financial sector today, that the sector would be an underperformer in the next five years.

Abnormally good or abnormally bad conditions do not last forever. - Benjamin Graham

Sensex Nifty EPS after one month of results

The result season is almost midway and the people are eager to know what the Sensex and Nifty EPS would be at the end of this quarter. Till now many big companies like Infosys, Wipro, TCS, RIL, HDFC Bank, BHARTI, ICICI Bank, Hero Honda, Maruti, Sterlite has announced results. The companies which have already announced results have a weightage of around 50.25% in Sensex. So we are clearly almost midway.

Many of these companies reported bumper results. Hero Honda, Maruti and Sterlite reported more than 100% increase in net profits. RIL, HDFC Bank, ICICI Bank and TCS announced profits that are 30% or more higher than the same quarter last year. Shouldn't this translate to a surge in Sensex/Nifty EPS? Guess what? Sensex EPS is up from 806.81 on 4 February 2010 to 17558.71/20.69=848.66 today. The big results that are still pending are L&T, HDFC, ITC, ONGC, SBI and BHEL.

Sensex - Nifty EPS after Q3FY10

Sensex EPS stands at Value-16224.95/PE-20.11=INR 806.81 as per BSE on 4 February 2010. Nifty EPS stands at Value-4845.35/PE-20.84=INR 232.5 as per NSE. ACC and Ambuja results were still not counted so this may change a little bit.
S&P CNX 500 EPS stands at Value-4139.7/PE-18.6=INR 222.56. BSE500 EPS stands at Value-6484.64/PE-20.06=INR 323.26 while that of BSE SMALLCAP EPS stands at Value 8344.74/PE-16.02=INR 520.895.

The following table may summarize better:

Date	Sensex	Nifty	S&P CNX 500	BSE 500	BSE SMALLCAP
Jan 7, 2008	734.39	222.629	203.26	295.67	603.15
Mar 9, 2009	702.27	210.74	174.99	254.52	482.61
Feb 4, 2009	721.71	210.91	174.92	278.62	599.46
Today	806.81	232.5	222.56	323.26	520.895
Two Year CAGR	4.8%	2.19%	4.64%	4.56%	-7.07%

This shows that even though the profits of Indian companies may have risen by 20-25%, due to dilution of equity, the EPS has risen by 10-12% for Sensex and Nifty. The rise in EPS for broader indices like S&P CNX 500 and BSE500 is more due to the fact that they fell more too compared to Jan 7, 2008 levels. For all the indices, the EPS growth is less than 10% when compared to January 7, 2008 in two years, i.e. less than 5% compounded annually and negative for BSE SMALL CAP index. People are still optimistic and saying INR 1250 EPS for Sensex and INR 375 EPS for Nifty in FY12. Pretty stupid forecasting.

India Inc is not deleveraging at all

World over the private sector is reducing its debt but in India, the party is still not over. Companies, especially small by size, are continuing their debt binge. Even the banks are lending without strict lending norms as can be seen in case of many companies.

The total outstanding debt of 473 BSE SMALL CAP Index companies stood at approximately INR 1,68,000 Crore at the end of FY09. This only includes debt of standalone non-financial entity. BSE SMALL CAP index's total market cap is just INR 3,22,680 Crore, with P/E of 17.68 and P/B of 2.13. This indicates that net profits of BSE SMALL CAP index would be around INR 18,250 Crore (and lower if we exclude financials) and Book value around INR 1,51,500 Crore (and lower if we exclude financials). Thus the total outstanding debt is even more than the book value (or net worth or shareholders' equity) giving debt/equity of 1.1 (higher if financials are excluded). Since the interest rates are low right now and the profitability of many companies is above average, the companies have been able to bear their interest burden. Reverse the two and the situation will become completely different. If interest rates increase and operating margins contract, the outcome will be nothing but horrible. Even with the current scenario, it will take more than nine years for companies to pay their debt completely. The only thing difficult to predict is the timing. The real punishment will be to the banks since their assets will deteriorate.

Compare this to companies belonging to BSE 500 index. The total outstanding debt of 500 BSE 500 Index companies stood at approximately INR 7,68,000 Crore at the end of FY09, excluding that of financials, 4.5 times that of BSE SMALL CAP index companies. The total market cap of BSE 500 is at INR 55,00,000 Crore, i.e. 17 times that of BSE SMALL CAP index. The P/E of 21.16 and P/B of 3.79 gives net profits at INR 2,60,225 Crore and book value of INR 14,57,102 Crore. Thus total outstanding debt is much less than the book value, with debt/equity at 0.53. It will take just three years of profits to pay the debt completely.

This puts BSE500 companies in much stronger position than that of BSE SMALL CAP. This is just a conclusion based on average. The individual companies may vary. Also notice the fact that some companies like, 3i Infotech, Alok Industries are present in both the indices. This is just to highlight the fact that investing in small companies is riskier than that of larger ones. Even when it comes to restructure debt, the banks would provide favourable terms to big companies compared to smaller.

Is dubai the next bear stearns?

I am just trying to compare current crisis with one in the past. Bear Stearns had to borrow from Fed on March 15, 2008. JP Morgan then bid for Bear Stearns at USD 2 and finally agreed to pay USD 10 on March 28. There was a kind of panic in investors across the world for few days. The Sensex too declined from 16371.29 on March 29, 2008 to 15343.12 on April 4, 2008. There was a big rally after that to 17490.9 till May 5, 2008. And everybody knows what happened after that.

Some more EPS

Let's have a look at some more EPS numbers as shown in the table:

Index	Jan 7, 2008	Nov 4, 2008	March 9, 2009	Today
BSE500	8882.28/30.04 = 295.67	3879.58/12.8 = 303.09	2983.02/11.72 = 254.52	5945.36/19.67 = 302.25
SMLCAP	13975.19/23.17 = 603.15	4035.11/6.37 = 633.45	2866.68/5.94 = 482.61	6741.24/15.33 = 439.74
CNX500	5500.15/27.06 = 203.26	2421.25/12.42 = 194.95	1966.85/11.24 = 174.99	3727.45/17.6 = 211.79

From the above EPS numbers it is clear that the biggest variation in EPS was in BSE SMALL CAP index. The EPS went down from 633.45 in November 2008 to 439.74 today, a decrease of 30%. The SMALL CAP index was trading at a P/E of 23.17 in January 2008 and came down to a P/E of 5.94 in March 2009, a correction of 75% in P/E itself. The earnings went down by only 24% from 633.45 to 482.61. But the slide didn't end in March. The earnings declined to 439.74 today. Some of it has come due to changes in index constituents but a lot of it has come from profit declines. The SMALL CAP index went down from around 14K in Jan 2008 to 2.8K in March 2009, a correction of around 80% in around 15 months. If you consider the peak earnings of 633.45, at a level of 2866.68, the P/E came to around 4.53.

Surprisingly, Both BSE500 and CNX 500 EPS have gone beyond what it was in January 2008 but P/E has contracted and so the index values are still 33% below their lifetime high made in January 2008.

Sensex-Nifty EPS after Q2 FY2010

Sensex EPS increased from 771.5 after Q1 FY2010 to 15404.94/19.7=781.98 after Q2 FY2010. Nifty EPS increased from 223.4 after Q1 FY2010 to 4711.7/19.81=230.38 after Q2 FY2010. This compares with Sensex EPS of 10631.12/13.1=811.54 and Nifty EPS of 3142.1/13.76=228.35 on November 4, 2008.

This is a degrowth of EPS for Sensex and growth in EPS for Nifty YoY while QoQ both have seen increase. The reason for growth in Nifty can be attributed to new scrips like JSPL, Axis Bank, IDFC introduced in place of Tata Communications, NALCO and Zee.

Total Market Cap above GDP

One of the valuation that measures whether the stock market in general is undervalued or overvalued is the ratio of total market cap of all the listed companies to GDP. According to economic survey 2008-09, GDP at current market prices was INR 53,21,753 Crore in FY2008-09. According to the BSE, the total market capitalization of all the listed entities was at INR 58,46,175 Crore on Oct 20, 2009. I am not able to get the data for the FY2009-10, but as far as I can remember, the GDP this year will be somewhere around INR 60,00,000 Crore. This makes the current market cap to GDP ratio at 100%. This is much lower than the ratio of 170% reached at the time Sensex was at 21200 in January 2008 when total market cap was INR 80,00,000 Crore and the GDP in 2007-08 was INR 47,23,400 Crore. At the bottom when Sensex reached 8K in March 2009, the total market cap was around INR 30,00,000 Crore, while market cap to GDP ratio at around 56%.

This is despite the fact that many sectors are still not having a single big company listed. This includes Insurance, Restaurants, Advertising, Railways, and many more. Conclusion? The undervaluation of equities is gone.

How has Nifty composition changed?

I would like to compare the constituents of Nifty between 2003 and now. Here are some statistics:

• In 2003, there were eight companies belonging to FMCG sector in Nifty, namely, Britannia, Colgate, Dabur, Glaxo Consumer, HUL, ITC, Nestle and Tata Tea. Today there are only two companies from this sector in Nifty, namely, HUL and ITC. Just to add, ITC was only in cigarettes at that time. Today it is in cigarettes, biscuits and soap/shampoos too.
• In 2003, there were six companies belonging to Pharma sector in Nifty, namely, Cipla, Dr Reddy, Glaxo, Novartis, Ranbaxy and Sun Pharma. Today there are only three, namely Cipla, Ranbaxy and Sun Pharma.
  
• These two examples show that when a particular sector has a very high representation in an index, it collectively underperforms the index. Individual companies like Colgate, Dabur, Glaxo Consumer and Nestle might have outperformed the index but the bigger players like HUL and ITC clearly underperformed the index. Today sectors that dominate Nifty are
  

1. Finance with seven companies representing the sector in Nifty
2. Power with five companies in generation/transmission/distribution and five in equipment.
3. Metals with six companies in aluminium/copper, steel, and iron ore.
   

• In 2003, there were total 21 different sectors that were represented in the Nifty constituents (if banks and housing finance, petrochemicals and refineries, auto 2 wheelers and 4 wheelers, steel and aluminium, are considered separate. If they are combined, the sectors would reduce to 17). Some of them included Hotels (Indian Hotels), Shipping (Shipping Corporation of India), Chemicals (Tata Chemicals) and Media (Zee). Today there is no representation of these sectors in Nifty (ITC is more of FMCG now then hotels). Today the number of sectors represented in Nify have reduced to 19 only (if you consider oil exploration, gas transmission and refineries, steel, aluminium and metals, banks and housing finance, separate. If these are combined, the sectors would reduce to 14 only). This clearly shows that many big companies from a particular sector has been put in the index. The examples are
  

1. Finance where HDFC, HDFC Bank, Axis Bank, SBI, ICICI Bank, Reliance Capital and PNB all are part of Nifty.
2. Power Equipment where ABB, BHEL, Siemens, L&T and Suzlon are all part of Nifty.
3. Telecommunication services where BHARTI, RCOM, Idea and TataCommunications are all part of Nifty and if BSNL lists then it too will be included.
4. Power where RINFRA, RPOWER, NTPC, Tata Power and JSPL are all included.
5. Metals where Hindalco, Nalco, SAIL, Tata Steel, JSPL and Sterlite are all included.
   

• From the above examples, it seems NSE should put a cap on number of companies representing a particular sector in Nifty.
  
• Surprisingly, developed nation like the US does not have a single power company in the Dow Jones Industrial Average.
  
• There is no representation of Media/Advertising, Chemicals/Paints, Retail, Insurance (there is no seperately listed entity to represent this sector), Transport (Railway/Airlines), Textiles, Paper, Auto Ancillaries (including tyres), Logistics, Hospitals, Restaurants and Consumer Durables in Nifty.

We can conclude from this that investing in Nifty is not a diversified way of investing in the whole Indian economy. It is better to chose a broader index like S&P CNX 500 or BSE500.

BSE500 Replacement Candidates

According to me, any financial index should represent a diversified view of an economy. BSE500 is one such index which represents 93.2% of the total market capitalization of all the stocks listed on BSE. Due to my personal reasons, I feel the following stocks should not be part of BSE500 and should be removed from it as early as possible:

Company
Aftek
Cals
GTL Infrastructure
Ispat Industries
Karuturi Network
NDTV
Nirlon
NOCIL
Noida Toll Bridge

You can also think that these are possible candidates which can be removed from BSE500 in near future.

Is Sensex Cheap? - Part 2

I had put an estimate of thirty Sensex companies in the first part of this article. It seems that the first quarter results are out and there are surprises - both positive and negative. I want to revise the estimate as below. Also Ranbaxy has been replaced with Hero Honda Motors.

Company	Net Profit FY2010E	Free Float	Free Float Profit
ACC	1500	0.55	825
Bharti	9000	0.35	3150
BHEL	3750	0.35	1312.5
DLF	3500	0.25	875
Grasim	3000	0.75	2250
HDFC Bank	2650	0.85	2252.5
Unilever	2250	0.5	1125
Hero Honda	1800	0.5	900
Hindalco	2000	0.65	1300
HDFC	2800	0.9	2520
ITC	3750	0.7	2625
ICICI Bank	4000	1	4000
Infosys	6500	0.85	5525
Jaiprakash Associates	1100	0.55	605
L&T	4000	0.9	3600
M&M	1600	0.75	1200
Maruti	1500	0.5	750
NTPC	9750	0.15	1462.5
ONGC	17500	0.2	3500
RCOM	7000	0.35	2450
RINFRA	1750	0.65	1137.5
RIL	20000	0.5	10000
SBI	15000	0.45	6750
Sterlite	4000	0.4	1600
Sun Pharma	1500	0.4	600
Tata Motors	1250	0.55	687.5
Tata Power	1750	0.7	1225
Tata Steel	5000	0.7	3500
TCS	5750	0.25	1437.5
Wipro	4500	0.2	900
Total			69465

The major increase is coming from Cement (ACC, Grasim and JP Associates), Auto (M&M and Hero Honda), Tech (Infosys, Wipro, TCS), Power (NTPC, Tata Power) and Banks (SBI). The major decrease is coming from Oil and Gas (RIL) and FMCG (Unilever). The market cap of Sensex EOD - 5 August 2009 is INR 11,60,461 Crore at the index level of 15903.83. This makes a forward P/E of 16.7 not as cheap as it was when we estimated in May. The EPS comes out to be 952, 3.5% higher than 920, what we estimated last. Remember that many companies have diluted their shares or are looking to dilute. These include Tata Steel, DLF, Tata Power, RINFRA, Sterlite and HDFC. Some of that dilution has already been in the Sensex Market Cap. The last time we took the data, Sensex was at 13589.23 with Market cap of 981352. The latest index was 15903.83 with a market cap of 1160461. Thus index has increased by 17.03% but market cap has risen by 18.25%, i.e. 1.18% more.

People are still talking about 1050-1100 EPS of Sensex in 2010. I am not sure where they are getting their estimates from. This is still too early to comment since only Q1 results are out and three quarters left to go.