POST MAYAN CALCULATION By Utpal Choudhury Nifty: 5834 (22 April 213) Nifty Target: 67 by March 214 This is, in fact, the follow up of our earlier strategy report, 'Decoding Mayan Calendar' in September 213. In that report, which we found difficult to sell, we gave a Nifty target of 592. The Nifty surpassed that target in December 212 and crossed even 6 mark. Soon lots of reports came from the biggies suggesting higher targets for Nifty. Business news papers and TV channels went gungho with analyses of those reports justifying higher targets. And we postponed our report for the time being. Now, as the atmosphere is more sombre, following the retreat of the Nifty and without the biggies being vocal about the market, we decide to release our readings on markets over longer term. Like the earlier report we prefer to take a valuation approach. And that has been yielding decent results for us over longer term. Our main argument is that India is not going to defunct in near future. So, any investment at right valuation would definitely give return for a longer term investor. Observations: Forward Nifty over discounted. # On trailing price earnings basis the Nifty is at a justified level. Current Nifty PE is at around 16, which is also a 1year median. # Bloomberg consensus estimate FY14 forward PE stands at 13 over discounted. # On trailing EV/EBITDA basis Nifty is justified at current 1x against a 1year median of 1.7x # Except Brazil other BRIC countries look either cheap or at par with India. # China is at par with India in terms of EV/EBITDA and cheaper in terms of PE valuation. # US shows a negative equity premium and so China the earnings yields are higher than the respective riskfree rate. We continue to remain positive on both. # Sectorwise valuation is nonuniform, while sectors like FMCG are highly overvalued, capital goods are grossly undervalued on trailing basis. Inference: Nifty set to return 2%+ over FY14. # As per current Bloomberg estimate the Nifty earnings is expected to grow at 22% over FY14. # Going by that Nifty should stand at around 7 at the end FY14 under normal circumstances implying around 2% return. However, we go conservative. # Over longer term, a valuation based sectoral strategy could prove best to outperform the Nifty. # Lower PE and higher EV/EBITDA of China indicates higher leverage. # US, as per Bloomberg consensus, is estimated to grow at 9% over next two years. We opine that # Investors invest for return. That is caused by growth. Any hurried movement causing a more negative real return would jeopardise foreign money flow. # To get the confidence of foreign investor inflation control is necessary, such that tough CAD situation could be addressed with ease. # Governments strong steps to cut deficit is welcome step, while some populist measures resulting into increased subsidies forcing lowered plan expenditure is disturbing. The other factors # The ecopolitical condition for India is yet to be favourable. # 214 general election may result into a hung parliament the worst thing to happen. # US is recovering though, there is no clarity for Europe as yet.
Nifty has 5% long term upside probability Fig.: Nifty PE trend over last 1 years: 3 25 2 15 1 5 NIFTY PE Sep3 Dec3 Mar4 Jun4 Sep4 Dec4 Mar5 Jun5 Sep5 Dec5 Mar6 Jun6 Sep6 Dec6 Mar7 Jun7 Sep7 Dec7 Mar8 Jun8 Sep8 Dec8 Mar9 Jun9 Sep9 Dec9 Mar1 Jun1 Sep1 Dec1 Mar11 Jun11 Sep11 Dec11 Mar12 Jun12 Sep12 Dec12 Mar13 Based on historical data, Nifty s average trailing PE multiple stands at 16x. That means 5% of the time the Nifty PE remains at above 16x and for another 5% time the valuation remains below that. Thus, there is an absolute clear game tactics for the longer term player buy Nifty below 16x and sell above 16x. Currently Nifty PE stands at around 15 indicating 67% upside probability and 33% downside. Similarly another valuation measure EV/EBITDA of Nifty is also at 1x, which is almost equal to its longterm median of 1.7. Fig.: Statistical characteristics of Nifty The longterm median trailing PE for Nifty is 16, implying 5% upside probability and 5% downside. The probability of Nifty PE moving above 18 is only 25%, while moving downward is 75%, as indicated by Third Quartile (Q3) The probability of Nifty PE remaining above 14 is 75%, as indicated by Third Quartile (Q3) Fig.: Nifty Downside and Upside Probabilities at various PE. Ni y RiskReturn Probability 1% 75% 5% 25% % 25% 5% 75% 1% PE > 22 PE > 19 Probability for downside Probability for upside PE > 16 PE > 13 PE > 1
Fig.: Nifty PE frequency distribution Earnings degrowth may lead to overvaluation: As PE depends on both absolute level of Nifty and its earnings, any degrowth of Nifty earnings can lead to overvaluation. However, such occasion is rare and only seen during FY9, as depicted by following figures. Fig.: EPS and Nifty over 1 years, restated at 1 6. 5. 4. 3. 2. 1. EPS_1 Index_1 Oct3 Mar4 Jul4 Nov4 Mar5 Jul5 Nov5 Mar6 Jul6 Nov6 Mar7 Jul7 Nov7 Mar8 Jul8 Nov8 Mar9 Jul9 Nov9 Mar1 Jul1 Nov1 Mar11 Jul11 Nov11 Mar12 Jul12 Nov12 Mar13 Jul13 Nov13 Mar14 Jul14 Nov14 Mar15 Nifty falls sharp during 28 That is followed by its earnings. Earnings fall during FY9. However, during FY9 Nifty bounces back despite fall in earnings. Fig.: Nifty and PE Band over last 1 years. 14 12 1 8 6 4 2 NIFTY INDEX 25 2 15 1 Index & PE Band Oct3 Mar4 Jul4 Nov4 Mar5 Jul5 Nov5 Mar6 Jul6 Nov6 Mar7 Jul7 Nov7 Mar8 Jul8 Nov8 Mar9 Jul9 Nov9 Mar1 Jul1 Nov1 Mar11 Jul11 Nov11 Mar12 Jul12 Nov12 Mar13 Jul13 Nov13 Mar14 Jul14 Nov14 Mar15 Nifty falls sharp during 28 and touches the lowest of the PE range at 1x towards the end of 28. Nifty bounces back during 29, while the earning fall sharp catapulting the Nifty up to 25x. So, one, that shorted at the highest PE during the period perhaps didn't make money, but one that longed at the lowest PE during 28, certainly made a humongous fortune. For India being a growing country, without a catastrophic event, the earnings is bound to grow may be at a varying speed. Buying at a lower valuation will definitely give investor money over longer term.
Fig.: Nifty EPS trend over last 1 years. 6. 5. 4. 3. 2. 1. EPS Oct3 Mar4 Jul4 Nov4 Mar5 Jul5 Nov5 Mar6 Jul6 Nov6 Mar7 Jul7 Nov7 Mar8 Jul8 Nov8 Mar9 Jul9 Nov9 Mar1 Jul1 Nov1 Mar11 Jul11 Nov11 Mar12 Jul12 Nov12 Mar13 Jul13 Nov13 Mar14 Jul14 Nov14 Mar15 Setting FY14 Nifty target at 67 This is based on the assumption that the Nifty earnings would grow at 15% and Nifty PE would be at its longterm average of 16x. However, one school of analysts doubts a 15% earnings growth of Nifty, given the recent downward revision of GDP growth. On the other hand the Bloomberg consensus Nifty EPS suggests a 22% growth. We prefer to present the matrix indeed. Fig.: Nifty at different level of EPS and PE. *CRNT BLB: Current fiscal Bloomberg estimate **NXT BLB: Next fiscal Bloomberg estimate Fig.: Nifty return at different level of EPS and PE. The 1year forward PE (Bloomberg Estimate) stands at around 13x and 2year forward PE stands at around 11x, against their historical medians of 14.4x and 12.3x respectively. That implies that Nifty is undervalued on forward basis.
Fig.: Nifty 1year and 2year forward PE Ni y Forward PE 35. 3. 25. 2. 15. 1. 5. 1Yr Frwd PE 2Yr Frwd PE Dec3 Jun4 Dec4 Jun5 Dec5 Jun6 Dec6 Jun7 Dec7 Jun8 Dec8 Jun9 Dec9 Jun1 Dec1 Jun11 Dec11 Fig.: Restated Nifty EPS, Indian Nominal GDP and Nifty. 6 5 4 Nominal GDP Index EPS 3 2 1 Nifty EPS and Nominal GDP of the country maintain a closer relation. Nifty's movement is much volatile, while the primary direction is maintained along side its earning and GDP Thus a proper understanding of ideal Nifty gives an opportunity to make decent return. Index EPS tends to outperform GDP owing to the Nifty's selection bias. Only good stocks are included in the Nifty. Dow set for decent return We were bullish on US in our last report "Decoding Mayan Calendar". The US market has appreciated around 7.5% since then. The reason behind our remaining positive was cheaper valuation, followed by expectation of economic stability going forward. We continue to remain positive. Interesting points to note that the current Dow enjoys a negative equity premium with earning yield more than the current interest rate. So we expect equity rerating. Fig.: Declining valuation trend of the US market 25 Index PE & EV/EBIDTA 2 15 1 5 PE_RATIO EV_TO_T12M_EBITDA Jun4 Jun5 Jun6 Jun7 Jun8 Jun9 Jun1 Jun11 Jun12 Jun13 Jun14 Jun/3 Dec/3 Jun/4 Dec/4 Jun/5 Dec/5 Jun/6 Dec/6 Jun/7 Dec/7 Jun/8 Dec/8 Jun/9 Dec/9 Jun/1 Dec/1 Jun/11 Dec/11 Jun/12 Dec/12 The valuation of the US market has shown a continued fall over last 1 years though it has much stabilized over last four years. Both PE and EV/EBITDA valuation shows identical trends. We are not very sure, whether the declining trend is leading us to a regime change and a new normal.
However, a look at the diverting trend of earnings yield and bond yield suggests that a conversion is rather more likely going forward than establishing a new regime of low valuations. Fig.: Diverting earnings and bond yield of Dow: 1 9 8 7 6 5 4 3 2 1 Earngs Yld EQY_DVD_YLD_12M USGG1YR INDEX Jun4 Jun5 Jun6 Jun7 Jun8 Jun9 Jun1 Jun11 Jun12 Jun13 Jun14 Diverting trend of earnings yield and treasury yield indicates a possible conversion going forward implying higher return for stocks. This is also may be a result of diverting fiscal and monetary policies expansionary monetary policy and restrictive fiscal policy. Fig.: Statistical characteristics of Dow Jones over last 1 years: Statistically, Dow trades at a median PE of 16x against current PE of 14x Similarly in terms of EV/EBITDA also Dow is trading cheaper at 8.3x compared to its longterm median of 9.3x. Bloomberg estimates the earnings growth to be 9%+ till the end of the year, implying a decent upside. Based on the estimate the forward PE stands at around 13 against Dow's average 1year forward PE of 14.6+. If Dow reverts to its historical median of 16x, then the return could be as high as 3%. Higher current earnings yield compared to the interest rate logically reinforces our expectation of equity rerating. Fig.: Dow at different level of PE and EPS
Fig: Dow return at different level of PE and EPS Will China surprise? In our September 212 strategy report, Decoding Mayan Calendar, we were positive on China only looking at its all time low valuation. The Shanghai Stock Exchange Composite Index (SSE Composite) has not moved anywhere since though, we remain positive. That is reinforced by a recent report by The Economist, which states that over last four quarters service sector of the country is performing phenomenally and set to surpass manufacturing. That is the characteristics of a maturing economy. Moreover the very small size of its service industry indicates immense scope for growth. Another important point is negative equity premium the earnings yield of SSE Composite is higher than the longterm interest rate of China. Logically, either there would be increase in interest rates or stock price. We believe in the later. The valuation of SSE Composite is characterised by high volatility and continuous decline over past 1 years. Both in PE terms and EV/EBITDA terms, the index are trading at near all time lows. That apparently makes China extremely cheap at present. Fig.: Lowering valuation of SSE Composite 6 5 4 3 2 1 Index PE & EV/EBIDTA PE_RATIO EV_TO_T12M_EBITDA 6/3/23 12/3/23 6/3/24 12/3/24 6/3/25 12/3/25 6/3/26 12/3/26 6/3/27 12/3/27 6/3/28 12/3/28 6/3/29 12/3/29 6/3/21 12/3/21 6/3/211 12/3/211 6/3/212 12/3/212 6/3/213 12/3/213 6/3/214 12/3/214 Where the volatility is high, marked by high standard error and the data shows a tendency of regime change, general statistical data may not be that helpful. Even then for the curious ones, we present the basic statistics of SSE Composite over last 1 years. Fig.: Statistics of SSE Composite over last 1 years: Current PE of the index is very near to its 1 year minimum. EV/EBITDA is, on the other hand, in between the 1year median and 1 st quartile.
Higher EV/EBITDA and lower PE indicates increased debt burden. Higher earnings yield than interest rate shows irrationalism. Either the interest rate should go up or the stock price. For our PE analysis, a decomposition of the Index and EPS shows an encouraging picture. Fig.: SSE Composite Index and its earnings 8. 7. 6. 5. 4. 3. 2. 1. EPS_1 Index_1 6/3/23 6/3/24 6/3/25 6/3/26 6/3/27 6/3/28 6/3/29 6/3/21 6/3/211 6/3/212 6/3/213 6/3/214 By and large, earnings have been growing over the period, indeed with some volatility. While the Index has been more or less stagnant. Given that the data is correct, the behaviour of the index is irrational. That is reinforced by the fact that the risk premium for Index is negative with earnings yield more than interest rate (See previous table). Thus there is all the logic to believe a rerating going forward. Fig.: SSE Composite for different earnings growth and PE Sectoral Snapshots Based on our statistical data, we take a look at the sector that is purely on trailing basis. Thus a reader may find it contradicting with our individual analysts' sector valuations, which are based on forward estimates. Health care as an index, on trailing basis, looks cheaper. However, we understand that it is improper to put all the pharma companies in one basket. Fig.: 1Years statistics of BSE Health Care Index Auto sector also looks cheaper, while our auto analysts foresee some shorter term hiccups. For a longer term player, it may be an opportunity to buy. Some downside risks cannot be ruled out though.
Fig.: 1Years statistics of BSE Auto Index Power is highly skewed towards higher valuation though it is reeling under crisis at present. If any body likes to go Sir John Marks Templeton way, who bought stocks during the World War II, it is perhaps the right time to buy the sector. Fig.: 5Years statistics of BSE Power Index Capital Goods is another story similar to power and we are longterm positive. Fig.: 1Years statistics of BSE Capital Goods Index Oil & Gas has been another sector that looks cheap on trailing basis. With lowering crude price it definitely looks better on forward basis. The sector has been trading near its all time low valuations for quite some time. Fig.: 8Years statistics of BSE Oil & Gas Index