PE Multiples: Does the number paint the full picture, decodes Naveen Chandramohan

As an investor in the Indian equity markets, it is appropriate to question the valuations of the market, terming it ‘expensive’ or ‘cheap’ depending on the number.

The question has more relevance today, considering the ‘absolute’ valuations are at the higher end of the range for the markets that we have witnessed over the last 20 years (the Indian markets, benchmarked by the Nifty 50 has traded between a valuation band of 12 and 38 from a forward 1Y multiple over the last 20 years).

It is natural that this environment causes a certain degree of concern around valuations and the ability for portfolios constructed today to compound capital over the next 5+ years.

We spoke to Naveen Chandramohan, Founder and Fund Manager at ITUS Capital to help us understand the Price Earnings multiple and its implication:

PE (defined as Price Earnings multiple) is one metric that is easily available in the toolkit of the investor, it is important to pay equal if not more attention to the earnings growth of a business.

The collective market will often value consistency of growth in the underlying businesses with an expensive lens, as these businesses tend to create value over time.

Looking at the example of Avenue Supermarts, which was expensive from a PE valuation metric when it came out with an IPO in 2017 (was priced at a PE multiple of 90x 1Y earnings). The shareholder value has grown 10x over the last 4 years and is still considered expensive.

One of the big learnings for me as an investor was to look at the quality of earnings of the business, which has compounded at 20% since then.

More importantly, as a country, we do not have an organized retailer in India with a clean balance sheet listed in the country (clean defined by the capital structure and the debt on the balance sheet).

The scarcity value of the business means that one does not have an alternative to get exposure to the organized retail market growth in India.

Unfortunately, a metric like PE in this case while can act as a tool, will never paint the true value of a business over time (which is better defined by the growth it generates through its earnings and cash).

Today, when one looks at the earnings of businesses across sectors, the absolute earnings and earnings growth across sectors will look robust.

As an investor, it’s important to segregate the sustainability of the earnings of individual businesses and look to own those in the portfolio, which can continue to show cash-flow growth over time.

In a bull market, like we are in now, every business we buy looks like winners (especially when we have a confirmation bias from everyday price moves that substantiate our picks), however, it is now more than ever that an investor needs to have the willingness to pay up for sustainable earnings growth, rather than buy ‘cheap’ businesses as a measured by PE multiples.

The value creation from here will be through owning good quality businesses rather than worrying about market PE multiples.

(Disclaimer: The views/suggestions/advice expressed here in this article are solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)