27 October 2009

27 October 2009

Making sense of the Market thro’ Sensex@MRP

The BSE Sensex is the barometer of the mood of the Indian stock market. From a Jan 2008 high of 21,000, it touched a low of 7,697 in October 2008. Now in October 2009, 1 year later, we are around 17,000.

MRP is the maximum price one should pay for the stock.

There is much debate, lots of opinions being expressed on TV, in the pink papers, in the Internet on: Are these levels justified? Is the Sensex due for a correction? Where will the Sensex be by the year-end and the next year? In this report, we suggest a way to ‘Make sense of the Market’ thro’ a concept that we as consumers are all familiar with: MRP- Maximum Retail Price. When we go to buy a soap, a shirt, a chocolate we look at the MRP. Don’t we wish our stocks come with an MRP marked on them? At Moneyworks4me.com we have done precisely this. Let’s see how.

Minimum Expected Rate of return when you invest in stocks should be 15% CAGR.

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What should be the basis of calculating the MRP of a stock? The maximum price that an investor should be willing to pay for a stock today depends on the return on the investment that he expects when he sells the stock in the future. When you invest in stock markets you are taking on additional risk which you would avoid if you invested in say bank Fixed Deposits. Hence while calculating the MRP, we have taken a Minimum Expected Rate of Return of 15% CAGR.

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Making Sense of the Market thro’ Sensex@MRP

The Sensex @ MRP indicates the point beyond which markets are driven more by liquidity and irrational expectations.

The next challenge is: How do you estimate the future price of the stock? Here we are guided by what Benjamin Graham has said about the stock market. He said that in the short term the stock market is like a voting machine and in the long term it acts like a weighing machine. What this means is that the future price of the stock, in the long term depends on the real worth of the stock i.e. its ability to generate earnings per share, EPS. Thus as a savvy investor, you must track the EPS growth rate of the company you are investing in. This will enable you to estimate the future EPS of the stock.

How do you calculate MRP?

At Moneyworks4me.com, we have computed the MRP of all the listed stocks after a thorough analysis of the companies, their financial track records and their future growth prospects. So how do we find at what level the Sensex is sensible? Considering that the Sensex stocks are the top traded stocks of the country, we can expect them to be traded at their MRPs. So let’s see if we can make sense of this “barometer of the Indian Stock Markets” and arrive at an indication of whether the Sensex is fairly valued or whether irrationality is driving the markets. The obvious method is to find out at what price should each of the Sensex 30 stocks trade at, i.e. their MRP. We can then plug in these prices and check out what could be considered as a sensible level for the Sensex. We like to call it Sensex@MRP. The free float market capitalization at the MRP of the individual stocks as computed by us at Moneyworks4me.com and share data as on 14th Oct 2009 is Rs.1,323,663 Crore. Using the index divisor 74.42 (as on 14th Oct) the Sensex@MRP is 17,786. Sensex@MRP Calculation: Free Float Mkt. Cap. using MRP

1,323,663

Index Divisor

74.42

Sensex @MRP

17,786

Factoring an estimated 15% increase for the September quarter earnings (YOY) of the Sensex companies, the Sensex@MRP goes up by 691 points to 18,477.

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Making Sense of the Market thro’ Sensex@MRP

Any bad news can trigger a sell off and a correction.

So what does the Sensex@MRP tell us? Should we be buying or selling? Isn’t this the question being asked often? What we can definitely conclude is that the market is approaching its outer limits. This is certainly not the time to buy stocks without looking at valuations and hope that another bull run will happen. Any bad news can trigger a sell off and a correction. It’s not that all the problems of the past are over and we are on a fundamentally strong wicket. It is just the increased liquidity that has attracted money into the market. Here is what we recommend you do: The real question you should ask yourself is: Should you be willing to buy stocks at their MRP? At MRP you can expect to get a 15% return on your investment. But have you factored in a Margin of Safety as the guru Benjamin Graham insists on doing? No you haven’t! This is crucial as you should be selling stocks which have crossed their MRP and buying only with a Margin of Safety.

Sell stocks which have crossed their MRP and buy only with a Margin of Safety.

As wise investors you should sell off stocks which are trading way above their MRP and you have already made handsome gains. Similarly if you have invested in mutual funds, review their performance and consider starting to sell. Use the money if you need to or just park it and wait for a correction. If you strongly believe a significant correction is unlikely to happen and wish to remain invested in stocks, do so only in select stocks trading close to their Discounted Price (half of MRP). Only a few good stocks are now available at less than Discounted Price. We believe the Sensex around 18,000 indicates the level beyond which the markets may be driven more by liquidity and irrational expectations about the future. Have we been cautious or aggressive when predicting the future EPS and P/E? Maybe we have been a tad cautious. The MRP is based on the latest TTM EPS, so if you expect an increase of 10% in the EPS in the next few quarters shouldn’t the Sensex touch 19,500. Maybe it will, considering that there is too much of good news floating around in the media. Maybe the market has already factored that in. Maybe it will fall if the FIIs decide to book their profits and take their money someplace else. But then all these ‘may-bes’ make it a gamble. Is that what you want to do?

Equity Analyst: Nikhil Kale [email protected]

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Making Sense of the Market thro’ Sensex@MRP

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