The stock market goes through periods of ups and downs depending on the mood amongst the investors. Usually, the market gets optimistic, driving up share prices. This is then followed by what experts call a 'correction'. This usually happens because short-term traders sell shares to book profits.
Recently, the Indian market has been on a bull-run, except for brief corrections. The benchmark indices Sensex and Nifty hit new lifetime highs. The BSE Sensex crossed the 29,000-levels, while the Nifty hovers near the 9,000-mark. Every day, these indices jump some more. Some analysts suggest this rally is on the back of expectations of a 'big bang' Union Budget.
Share prices are a reflection of the company's perceived value. When the value increases, share prices rise. A company's value is derived from its profitability. For this reason, markets closely monitor earnings announcements. A rise in profit growth always cheers the market. It shows that the rise in share price is worth it. A slowdown in the economy kept profit growth subdued the past many quarters. Markets were optimistic about a pickup in growth this fiscal year. However, earnings data for the quarter ended December 2014 showed profits fell for many large and medium-sized companies. Profits of the companies that form the Sensex fell nearly 6% in the December quarter on a yearly basis, according to a Kotak report. "Reported results were boosted by extraordinary gains in NTPC and Tata Steel, and would have been even worse otherwise," the report added.
Stock prices reflect the expected future value, not just the current value of the company. So, analyst expectations play a big role in how stock prices move. The poor earnings performance of major companies in the December quarter shows economic recovery has not translated into profit growth for companies. Moreover, even when profits start rising, it is expected to grow slowly. As a result, analysts are cutting their growth estimates for the full fiscal as well as their next fiscal. "Analysts over the past month have cut their net profit forecasts for large and mid-sized companies by 2.8% on average," according to a Reuters report.
How do you know if the amount you are paying for a single share is too high or low? To measure this, analysts use the Price to Earnings or PE multiple. The PE ratio compares the share price with the company's net profits or earnings per share (EPS). The higher the multiple, the costlier the shares. Everyone prefers to buy the shares at cheaper valuations. When earnings growth falls, a share automatically becomes costlier. Currently, the market is quite expensive, according to the Kotak report. PE ratio for the Sensex on the basis of the expected profits in the current fiscal stands at 19.8. This is much higher than the average PE multiple of 15-16. Whenever the PE multiple shoots up, markets fall briefly to adjust valuations.
The only factors sustaining the market bull run currently are positive macro-economic factors like falling inflation, interest rates and current account deficit - the amount India owes to the world in foreign currency. The other factor supporting the market is the anticipation of a reform-oriented Budget. If the Budget fails to cheer markets or if the economic data disappoint, the market could fall.
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