How Sensex compares on P/E

One of the most popular measures of valuations remains the P/E ratio. The Sensex P/E tends to be less volatile and hence also more representative. Over the last 20 years, the current P/E of the Sensex at 31.94 is highest on record. In fact, three highest P/E levels have been in the last 3 years. Clearly, the Sensex is beginning to attach high valuation to the earnings, almost akin to what the US markets command. Previous bull runs peaked at 23X, but now is nearly 32X. 

Dividend Yields and P/BV

Another way to look at the valuations of the Sensex is via P/BV and DY. Let us look at P/BV first. Interestingly, P/BV of the Sensex is still way below the former peaks. In 2007-08, the P/BV stood at 5.47 compared to 3.32 today. Despite, very limited capital investments, the P/BV has been lower and with capex plans on the anvil, this could fall further. However, dividend yields have fallen below 1 for the first time on average in the last 20 years. In short the signals from P/BV and dividend yield on the valuation front have been contradictory. How to interpret this data dichotomy? 

Sensex doubles in over a year

What perhaps raised this question of the Sensex being overvalued is the fact that the index has more than doubled from the lows of March 2020. It had touched a low of 25,638 in March 2020 and from that level the Sensex is up a full 116% in just 16 months. That is what is spooking market observers that the rally may have led to Sensex overvaluation pushing the index against a wall of worry. What this argument really ignores is that large Indian names have substantially cut down on debt and also cut down sharply on cost of production, which is evident from improved gross profits of companies across the gamut. 

Liquidity, oil and interest rates

There are three important aspects of the current rally we must not ignore. Firstly, the interest rates are at their lowest levels in history. Lower interest rates can justify higher P/E even with static earnings, due to higher discounted value of future earnings. Secondly, oil prices have played a major role. Median oil prices are substantially lower in the last 5 years than at any time in recent memory. That has led to a massive shift of wealth from the oil exporters to the oil importers like India. Finally, the real difference is the relentless flow of funds into markets. As long as liquidity flows last, everything else is immaterial. If there is one factor to watch, it is the pace and quantum of liquidity flows!