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March 8, 2000
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Is the P/E dead?The Money Bureau Had you bought shares of Larsen & Toubro in early January on the expectation of an economic turnaround and recovery in cement prices, your investment would have halved by now! If you though the auto industry is on the recovery path, you would have lost a packet on Bharat Forge falling from Rs 350 to Rs 152. And if you thought you were smart and expected fast moving consumer goods and pharmaceuticals to continue last year's dream run, you would be in for rude shock once again. Glaxo has fallen from Rs 793 on January 3, 2000 to Rs 465. Britannia is down from Rs 740 to Rs 470. What has happened to valuations and the principle of value investing? Has the economic turnaround story vanished from the stock market in the last two months? From the current stock prices, the answer seems to be yes for both questions. Just look at the price-earnings multiple (P/E) of companies, especially in the manufacturing sector and you will notice that many of them have halved from their January 2000 levels. The polarisation between the ICE (information technology, communication and entertainment) and the non-ICE stocks is getting wider and wider by the day. Most of the non-ICE stocks barring a few exceptions have nearly halved from their peak levels. There are many examples across sectors. The P/E ratio is one of the most widely used ratios in assessing a company's market performance. It is the ratio of the stock's price to its latest earnings per share. The ratio gives an indication of the premium at which the stock is available to its latest available earnings. When one says that a stock is quoting at 500 times its P/E, it means that the market price is 500 times its latest earnings. The P/E ratio makes comparisons with other stocks easy. For example Satyam Computer is currently quoting at a P/E of 175 while Infosys is quoting at a P/E of 312 times. BHEL is going at a P/E of 5.95 while TVS Suzuki is available at a P/E of 8 times its earnings. Isn't P/E a good enough criterion for stock-picking? Or has it lost its relevance in the market place? A look at the movement of the P/E ratios in this calendar year seems to indicate that P/Es are no longer as fashionable. BHEL was quoting at 10 times earnings on January 3, 2000 and is now available at less than 6 times. While the earnings haven't changed, the price has gone down from Rs 225 to Rs 131. Larsen & Toubro was quoting at about 38 times its earnings on January 3, 2000 but the P/E has come crashing down to 20. The Budget has caused a further decline in the P/E ratio of manufacturing companies, while ICE companies have seen their P/Es rise further. A look at the P/Es of the top companies in the A-group at the BSE reveals that the fall in the valuations in the non-ICE stocks has accentuated in the last week after the Budget. Have a look at at the fall in the P/E of the non-ICE stocks post budget and the P/E of ICE after the Budget day. P/E multiples for non-ICE stocks
P/E multiples for ICE stocks
Note: The latest trailing 12 month EPS is used for P/E calculations.
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