Big brokers are reluctantly lowering their earnings growth target, leading to the belief that the market

is undervalued. Is it based on false premises? Is the Indian market undervalued? This is the million-dollar question today. It is the inability of big investors to answer this question decisively that is leading to a sideways market with extraordinarily low volatility. The Sensex was around 18,300 in end-January. It is about the same today. Intraday volatility has dramatically collapsed. This is because the bulls are as confused as the bears and there is a complete stalemate. Could the cause of this confusion be the propaganda of big brokers who are calling the market undervalued? Their (bullish) argument is straightforward and is captured in a recent report of Kotak Securities. "The BSE30 is trading at 14.4X FY2012E EPS (full market cap basis) Downside risks of earnings exist but they have somewhat receded with cuts during the recently concluded 4QFY11 results season. The nature of earnings precludes large cuts unless macro-conditions turn drastically negatively. We find the valuation of the Indian market reasonable after a 10% correction." Well, this valuation exercise would have you believe that the market is a 'buy' at a forward P/E of 14+. That's finebut surprise, surprise, nobody is buying. The market is listless for days (today, it went down sharply and came up again) and weeks and more importantly, every rally is being met with selling. The most intriguing fact is that there are only a few occasions in the past when the forward P/E has been 14. On those occasions, long-term buyers have swooped in. So why not this time? Because the investors probably don't believe that the forward Sensex P/E is as low as 14, despite the bullish propaganda of brokerage houses. Neither do we, and here is the math. In 2010, the Sensex companies probably recorded an earning per share (EPS) of Rs834. In FY11, a robust year of recovery, the EPS was probably Rs1,013 (it is hard to decipher these EPS figures because the BSE, the Bombay Stock Exchange, does not give them). Three months of FY12 are about to get over. What would be the EPS of the Sensex in 2012 which would give us an idea whether the forward P/E of the Sensex is attractive or not at the current market level? Here is where confusion starts. The Bloomberg consensus estimate is Rs1,240. This assumes a rise in net profit of 22%. Is that a logical assumption, given that in a year when the skies were blue (FY11), the Sensex EPS rose by 21%. In fact, the March quarter performance of the Sensex companies was terrible. According to the head of research of Motilal Oswal Securities, Rajat Rajgarhia, quoted in CNBC, "Even during the crisis of 2008-10, we never saw such a magnitude of variation in our actuals versus the estimates. (For) the quarter which went by, we had the Sensex earnings almost being flat versus an estimate of 17%-18% growth." One of the reasons for this was poor results of State Bank of India and ONGCtwo heavyweights in the Sensex. But, according to Mr Rajgarhia, "Even excluding these two numbers, the profit growth for the Sensex was just 8%-9%which was very disappointing. At the end of this quarter, we saw a downgrade to the tune of almost 3%-4% to our FY12 earnings estimates. So, the revised estimates are just about at Rs1,200 for FY12."

Is that too optimistic? Not if you hear what broking companies are touting. Kotak Securities is hopeful enough that it is assuming an EPS of Rs1,210. The other estimates are even more bullish (those of Bank of America, Macquarie, and Citi cluster around Rs1,250). But even Rs1,200 of EPS assumes that the Sensex companies will grow their earnings by 18%-19%. Is this possible? We trolled the research reports of several large brokerages and found only assumptions and forecasts no logical build-up of credible arguments as to how growth will come back on its own. It seems merely a sunny extrapolation, wishful thinking. We believe that given how badly Sensex companies have done in the March quarter without any plausible reason and warning, the writing is on the wall. To know whether the market is overvalued or not, we will have to work with pessimistic assumptions, not optimistic ones, something that that analysts as a tribe are always loath to do. If the Sensex companies record an EPS growth of 13%, we get an EPS of Rs1,150 for 2012. At the current Sensex level of 18,300, that means a P/E of 16. That is not expensivebut not cheap either, as the brokerages are making it out to be. And if the EPS growth is lower at 10% (not impossible), EPS will be Rs1,120. For the Sensex to sport an attractive forward P/E of 14, it will have to be around 16,000. You can make your own assumptions and tweak the numbersbut at least don't go by what brokerages are saying