P/E ratio is always influenced by Cost of. Capital

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3 P/E ratio is always influenced by Cost of Capital 3

4 May62 May64 May66 May68 May70 May72 May74 May76 May78 May80 May82 May84 May86 May88 May90 May92 May94 May96 May98 May00 May02 May04 May06 May08 May10 May12 May14 May16 PE Multiples influenced by Global Cost of Capital US Market: 10 Yr GSEC Yield vs PE Multiple of S&P S&P 500 PE Ratio US 10 Year Yield Looking at data from the US, for the Long Term period , PE ratio of S&P 500 Index has been inversely correlated to the 10 Year GSEC Yield Source: Bloomberg 4

5 May62 May64 May66 May68 May70 May72 May74 May76 May78 May80 May82 May84 May86 May88 May90 May92 May94 May96 May98 May00 May02 May04 May06 May08 May10 May12 May14 May16 Average PE Ratio is a moving target Average PE Ratio over a period is inversely proportional to the prevailing interest rate regime 28.0 US Market: 10 Yr GSEC Yield vs PE Multiple of S&P Abnormal Valuation during tech bubble LT Average PE of the S&P500 index is 16.5x But the 10 year average PE varies around this as per the prevailing interest rates S&P 500 PE Ratio US 10 Year Yield As a result, the PE of the index can remain very high or low for extended periods depending on the prevailing interest rate regime Source: Bloomberg 5

6 Indian Markets appear Expensive, but ARE they? 6

7 INDIA: Market is at an all time high But are we at a market top? Sensex Index 35,000 31,259 30,000 25,000 20,000 15,000 10,000 5,000 Source: Bloomberg 7

8 Sensex appears expensive in terms of PE Ratio 26.0 Sensex PE Ratio Avg Sensex PE +1SD = 20.9 Average Sensex PE = 17.6 Avg Sensex PE +2SD = Avg Sensex PE 1SD = 14.4 Avg Sensex PE 2SD = 11.2 PE Ratio Average +1 SD 1 SD +2 SD 2 SD Source: Bloomberg, internal research SD Standard deviation 8

9 But to a lesser extent in terms of PB Ratio 7.0 Sensex PB Ratio Avg Sensex PB +2SD = 4.7 Avg Sensex PB +1SD = 3.9 Average Sensex PB = 3.1 Avg Sensex PB 1SD = 2.3 Avg Sensex PB 2SD = PE Ratio Average +1 SD 1 SD +2 SD 2 SD Source: Bloomberg, internal research 9

10 Current Valuations may not be stretched 10

11 7/1/2000 2/1/2001 9/1/2001 4/1/ /1/2002 6/1/2003 1/1/2004 8/1/2004 3/1/ /1/2005 5/1/ /1/2006 7/1/2007 2/1/2008 9/1/2008 4/1/ /1/2009 6/1/2010 1/1/2011 8/1/2011 3/1/ /1/2012 5/1/ /1/2013 7/1/2014 2/1/2015 9/1/2015 4/1/ /1/2016 Reason 1 Lower Global cost of capital Downward shift in US rates post the 2008 GFC has caused upward shift in the average PE Ratio Till 2007, Avg 10 Yr US Yield: 4.6% Avg SENSEX PE Ratio: 15.3x Post 2007, Avg 10 Yr US Yield: 2.6% Avg SENSEX PE Ratio: 18.1x Sensex PE Ratio US 10 Year Yield Source: Bloomberg, internal research GFC Global Financial Crisis 11

12 Reason 2 Reason 2 Valuations not only dependent on price Current Valuations appear expensive also due to depressed EPS SENSEX EPS at same level as March14 EPS suppressed due to losses posted by Metals and Corporate Banks Sensex EPS CAGR Mar12 to Mar17: 4% vs Mar01 to Mar12: 17% PE Ratio optically expensive as Earnings haven t gone anywhere Source: Bloomberg, internal research 12

13 Reason 2 Reason 3 Change in Index Composition More proportion of high PE sectors in 2017 as compared to Sensex High PE Sectors replacing low PE Sectors 19.1 PE of 2007 is very different from PE of 2017 due to change in index composition Weight of Low PE commodity stocks Metals + Energy has reduced from 24% to 11.6% Dec Jun Weight of High PE Consumer stocks & Pvt Banks has increased from 26% to 49% Change in Sector composition has caused an upward shift in the normal PE PE of 22.0x in 2007 was much more expensive than a PE of 22.0x in 2017 Source: Bloomberg, internal research 13

14 Markets not at Peak, As economy close to bottom 14

15 Latest period earnings growth is much lower than historical averages 0.1% 3 Yr Gr Rate 13.5% 5 Yr Gr Rate 3.9% 13.7% 7 Yr Gr Rate 7.2% 13.6% 10 Yr Gr Rate 3.9% 13.8% LT Gr Rate 13.1% 15.2% Mar93 to Mar17 Mar93 to Mar14 2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% Latest Period Hist Rolling Average Source: Bloomberg 15

16 Strong EPS Growth over next 34 years needed to push LT Growth Rate to Historical Average 3,000 Sensex EPS 2,500 2,000 1, s: EPS Growth Rate 18% 2000s: EPS Growth Rate 15% EPS CAGR of 17% from will only push up earnings Growth to 10% 2010s: EPS Growth Rate 7% 1, Source: Bloomberg, Internal research 16

17 Apr/01 Apr/02 Apr/03 Apr/04 Apr/05 Apr/06 Apr/07 Apr/08 Apr/09 Apr/10 Apr/11 Apr/12 Apr/13 Apr/14 Apr/15 Apr/16 Apr/17 Apr/01 Apr/02 Apr/03 Apr/04 Apr/05 Apr/06 Apr/07 Apr/08 Apr/09 Apr/10 Apr/11 Apr/12 Apr/13 Apr/14 Apr/15 Apr/16 Apr/17 Apr/01 Apr/02 Apr/03 Apr/04 Apr/05 Apr/06 Apr/07 Apr/08 Apr/09 Apr/10 Apr/11 Apr/12 Apr/13 Apr/14 Apr/15 Apr/16 Apr/17 Market tops coincide with overheating of economy Economy nowhere close to a top, more at the mid of the cycle 10 Core IIP YoY%, 6mma PV Sales Gr, 6mma 18.0 CPI Credit Growth (NonFood), 6mma Source: Bloomberg, internal research 17

18 Most macro variables are much lower than their 2010 peaks Fiscal Deficit 3.9% 6.5% Credit Growth (NonFood), 6mma 6.1% 26.4% CPI 3.0% 11.5% Current 2010 peak PV Sales Gr, 6mma 10.0% 37.0% Core IIP YoY%, 6mma 4.5% 8.2% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% Source: Bloomberg 18

19 Valuation Snapshot Dec07 Mar09 Mar10 Mar11 Mar12 Mar13 Mar14 Mar15 Mar16 Jun16 Sep16 Dec16 Mar17 Jun17 10 Yr Avg 5 Yr Avg PE Ratio NIFTY INDEX NSEMCAP INDEX Difference with NIFTY NSESMCP Index Difference with NIFTY Positive PE Ratio NIFTY INDEX NSEMCAP INDEX Difference with NIFTY NSESMCP Index Difference with NIFTY Yr Fwd PE Ratio NIFTY INDEX NSEMCAP INDEX Difference with NIFTY NSESMCP Index Difference with NIFTY PB Ratio NIFTY INDEX NSEMCAP INDEX Difference with NIFTY NSESMCP INDEX Difference with NIFTY Returns Valuations NIFTY INDEX appear expensive 59% 51% when 78% compared 10% with 9% LT averages; 7% 18% but 27% Nifty 9% PE needs 7% to be 4% looked 5% at in 12% the context 5% of near term average (19x) BSE500 Index 71% 59% 101% 7% 9% 5% 17% 33% 8% 8% 6% 6% 14% 5% In NIFTYJR the current INDEX regime 80% of dramatically 66% 153% low 5% cost of 7% capital, 7% valuations 20% 44% though 3% on the 9% higher 12% side, 7% aren t 17% as expensive. 5% NSEMCAP INDEX 87% 63% 128% 5% 4% 4% 16% 50% 1% 8% 12% 7% 19% 4% Market NSESMCP Index is in the initial 88% stages 73% of recovery 131% 0% with recovery 6% 7% in earnings 18% 51% growth 13% expected 19% 6% 6% 20% 5% Source: Bloomberg Midcap index PE of 30X is optically expensive due to several loss making companies (PSU, steel). Excluding these companies, positive PE is much lesser.. Due to the large midcap universe, index PE is not necessarily a correct representative of midcap funds PE 19

20 Summary The current Sensex PE ratio appears optically high when compared to Long Term average as: Market PE ratio is a function of global cost of capital. Given the current low cost of capital globally, the average PE ratio has been shifted upward Low earnings growth in the past 5 years (4% CAGR) have resulted in suppressed EPS Earnings growth is expected to rebound in the near future and catch up with its LT average of 13 14%, closer to nominal GDP growth Various macroeconomic variables like fiscal deficit, credit growth, PV sales etc indicate start of a recovery and not a market top Given the higher PE multiple, market may witness correction going forward. Any correction would give investors a good opportunity to participate in the long term earnings growth story of the Indian market 20

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