However, many experts believe that looking at ratios in isolation will not help investors understand the realities of the market and that high valuation may not be the only determining factor driving the market.
“Valuations are important in the long term, but they don’t matter in the short term. That’s because there’s never a right value for a stock, because it’s a very individual year,” says Mukesh Didiya, director of Ghala and Bhansali Securities.
“For example, a stock with a high P/E may go further because there is more demand for the stock due to higher earnings potential. So, there is always some confusion about the correct valuation,” he adds.
”If you look at the broader market, it’s difficult to pick a value. But if you do the bottom-up approach, you will still find many stocks with the right value in the market,” says Rajeev Thakur, CEO of Parag Parekh Financial Advisory Services. Although he is a strong believer in value investing, he says that looking at ratios alone is not the right way to invest in stocks.
”There are many things you have to consider. For example, you must determine whether the growth rate is sustainable or how much capital is needed to maintain growth. Sometimes, there will be volume growth, but margins may be under pressure. There are many issues to consider, just looking at the ratio is not enough,” he adds.
Some experts also believe that higher valuations can be justified if foreign investors continue to pump money into the stock market in the hope of better performance by Indian companies.
“Current valuations do not justify India’s long-term growth potential. The market trades at 17 times 2011 earnings potential and around 13.8 times 2012 earnings forecasts. It even carries around 50% premium for other emerging markets and around 25% premium for other global markets,” says Devendra Niyogi, founder and principal partner, Global Partners. He believes the premium can be justified if foreign investors continue to bet on Indian stocks.
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