Economic Times reports that the current valuations looks reasonable. I’ve analyzed the same and reached into my own conclusions. They says that at the peak of dotcom boom in 2000 SENSEX P/E was around 28. But I have got a chart of the same and it shows that SENSEX’s P/E Multiple during the dotcom boom was as high as 35.

Again they reports that "The BSE Sensex hit the bottom at 2,924 points in April 2003, when its P/E declined to 12.7". So it means that if we were to trade at the same P/E then SENSEX could go way down to 12,000 to 12,500 levels. Marc Faber earlier said that SENSEX may test 14,000 levels before slipping down to 12,000 levels.

The current market meltdown has left the investors shocked and stunned. The only question in everyone’s mind today is does the market have further downside left or has it bottomed out? Practically, everyone is offering some or the other opinion on this question.

We believe that the one of the fundamental ways of reviewing the current market conditions is to look at valuations in the light of their historical values. If, historically, a particular scrip was being valued at 10 times its annual earnings, then we can assume that it reflects its fair value. If the current valuations are substantially above these levels, it will mean that a further downside is to be expected.

The latest rally that the equity market witnessed throughout 2007 peaking in the first week of 2008 stretched the valuations to historic highs. The bullish enthusiasm meant that the future growth potential of companies was discounted at higher rates than witnessed in the past.

In terms of the market lingo, it meant that the price-to-earnings multiples (P/Es) increased to very high level. At its peak in the first week of January 2008, the Sensex P/E had breached the 28 level and it matched the levels last seen during the height of the dotcom boom in 2000.

Reminding of the crash of 2000 could be painful for many investors. It was not only severe, but also long-lived and the bear grip on the markets remained tight for years. The BSE Sensex hit the bottom at 2,924 points in April 2003, when its P/E declined to 12.7.

Only after this, the markets stabilized and then gained gradually. Since September 2007, in just three months, the Sensex gained around 33% — a gain that has been wiped out now. With the crash, the valuations too have moderated with the market capitalization of Sensex at just 19.4 times its constituents’ trailing 12-month earnings.

A study of the share price movement of the Sensex companies indicates that more than half of them are now trading below their 5-year average PE. Just 11 companies command a PE, which is higher compared with their average PE over past five years period.

Does this mean that fundamentally speaking, the valuations have become reasonable and there is little, if any, downside left? It may not be so. A closer look reveals that the 11 scripts with higher P/Es include RIL, ONGC, L&T , HDFC and ICICI. These companies together have 60% weightage in the Sensex, if their valuations were to come down to historical levels, the market will fall substantially.

Comparing the current crash with year 2000 puts forward a key question: will the aftereffects of the current crash continue over the next couple of years as witnessed in 2000? The answer would probably be ‘No’ , as the situations differ considerably.

India’s economy during the 2000-2003 period was passing through a lean phase and it was no wonder that it weighed down on the stock market. However, the economy is expected to post a growth of 8.7% in FY08 and the future growth, although slower, is expected to remain above 8%.

Looking at the situation from a different angle, market experts are expecting earnings per share of Sensex companies to reach around Rs 950-1 ,000 levels in FY09. Thus, the current Sensex level justifies itself even at a low P/E of 15-16.

And according to Vivek Patil (India’s foremost expert in Elliot Wave Analysis).

Remember, the Sensex, at Jan’08 low of 15332, has already lost 28%, which is a usual phenomenon every two years, even during the current bull phase. In ‘2004, it lost 32% from 6250 to 4227. In ‘2006, it lost 31% from 12671 to 8799. The bigger, 8-year cycle, however, calls for a much bigger, 55% cut, every 8 years. In ‘1992, Index lost 57% from 4546 to 1980. In ‘2000, it lost 58% from 6150 to 2594.

So as a conclusion my strategy is that I would buy more if and only if the SENSEX goes down to 14,800 levels or 30% correction from the top of 21,200. And then what if it didn’t stop there? Then the next level to watch out for are 12,000-12,800. So I would certainly buy more at those levels. And if it didn’t stopped even at those levels then the next level is 9,800 to 11,000. But that would be the worst scenario. I would appreciate your valuable comments

Source: Economic Times, Moneycontrol, ICICI Direct

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