Tuesday, February 3, 2009

Investor Survey: 21,000 Sensex in 2-3 years

"Many shall be restored that are now fallen and many shall fall that are now in honor" - Horace

The second half of the above quote by the famous Roman poet has already been validated by the Sensex, which fell precipitously from its lofty 21,000 levels to a lowly 8,000 or thereabouts. We now turn our attention to the first part of Horace’s quote. The question that would be uppermost in everyone’s mind would be, "Will the Sensex regain its lost glory of 21,000 levels and if yes, in how many years? Well, since the proof of the pudding is in the eating, we decided to toss the question up to the investor community through our Investor Survey

Equity master has asked the participants of the survey, "When do you see the BSE Sensex reaching its all time highs of 21,000+"

Investor Survey: BSE Sensex reaching its all time high of 21,000+?

If the replies are anything to go by, the recent correction has barely made a dent in the bullishness that people feel with respect to Indian equities. Nearly 9 out of every 10 people surveyed indicated that they expect the Sensex to retouch 21,000 levels within the next five years. If the five year period is further broken down, nearly 5 of those 9 people feel that the Sensex could reach its previous high as early as over the next 2-3 years while 3 out of 9 feel that it could take a little longer, 4-5 years, for the Sensex to reach the coveted mark. If one were to consider the maximum votes, the period of 2-3 years clearly comes out on top.

Now, why have the maximum number of people voted for 2-3 years? Is there a rationale to it or the numbers simply reflects the fact that some people are forever optimistic, regardless of the environment around them. To know the answer, let us try and understand the underlying scenarios that could lead to Sensex levels of 21,000 from a three year perspective.

At the broadest level, one needs only two things to arrive at a certain Sensex level. These are the P/E ratio and the composite earnings growth of the Sensex companies. For the P/E ratio, let us go back to historical averages. Monthly average for the Sensex P/E since the year 2000 gave us the multiple 18x. Please bear in mind that this is an average number and the Sensex P/E must have bobbed around this number on a lot many occasions. Since an eight year period is long enough a horizon, multiple of 18x will not be too outrageous an assumption to make.

Thus, after fixing 18x as the P/E multiple, let us arrive at the earnings growth that satisfies the criteria of a 21,000 Sensex in three years. Well, for the Sensex to touch 21,000 in three years, earnings for Sensex companies will have to grow at a CAGR of 15%. Is this too bold a target? Not really, because in the past, Sensex companies have grown at around a similar rate. And given that the long term fundamentals are largely intact, there isn’t any strong reason for the earnings growth to behave otherwise. Thus, we can conclude that most of the survey participants were right on the button when they said that Sensex might touch 21,000 again over the next 2-3 years. Of course, the future cannot be predicted with pin point accuracy but the risk reward ratio definitely seems to be in our favour.


No comments: