India markets: more value ahead or time for correction?

The Indian stock markets are racing ahead on the anticipation of strong future earnings, with both benchmark indices currently trading at a premium to 10 years average price to earning (P/E) multiples of 15.5 times.

Indian equities are trading at 16.7 times for FY15 (estimated) earnings, - a premium to most other emerging markets. Japan is the only country which is at a premium to India.

If corporate India delivers 18-20 per cent earnings growth for FY15-FY16, the current P/E of 18.8 times for both benchmark indices looks attractive. An earnings growth of about 20 per cent could lead to a FY16 forward P/E below 10 years' average of 15.5 times (source Motilal Oswal Securities).

India is the top-performing markets this year, with the Sensex delivering 23 per cent return in the current calendar year (CY14) till date. Only Argentina has outperformed India with 47 per cent returns in CY14.

Of the 50-Nifty stocks, 13 are currently trading at a discount to 50-Nifty's historic average, while the remaining almost thrice as many (37 stocks) trade at a premium.

Cairn, Dr Reddy's Labs, Infosys and ICICI Bank among others, are currently among those trading below the 10 years' average P/E.

TCS and HCL Tech in the technology sector and Lupin and Sun Pharma in the healthcare sector are trading above their historical PE averages. Public sector banks are also trading at a premium to their historic average P/E on account of a strong pick up in valuation after the Union budget.

Bharti Airtel, DLF and Hindalco are commanding very high premiums to their historic P/E averages mostly due to low earnings growth posted in the last couple of years.  

All cement companies are trading at huge premium to historic averages. Among automobiles, except Tata Motors, all companies are at a premium to the historic average.

Equity analysts are hinting at EPS growth of 15-20 per for FY15 and FY16. Credit Suisse in its June 2014 India Strategy report has reset EPS growth for the Nifty from 15 per cent to 18 per cent for FY16.

The momentum in the markets hinges on earnings growth, say analysts at UBS Research. But in the last three years, the actual earnings growth rate was much lower than the 15 per cent growth anticipated by analysts.

Motilal Oswal analysts expect profits of the Sensex and Nifty companies to grow at around 20 per cent in FY15Q1 against 11 per cent in FY14Q4. This would be the highest growth in the last nine quarters.