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Equity Valuation and Outlook for 2015

Equity valuations are always based on economic growth, earnings growth of companies and Price Earnings Multiples.
The above 3 principles were reinforced by Prashant Jain, the Chief Investment Officer in a recent note issued by HDFC Mutual Fund detailing their Equity Market outlook for 2015.
We should understand that stock markets are closely aligned to the growth in the economy.  The economic growth is synonymous with Gross Domestic Product (GDP) growth.    Prashant Jain jocularly mentions that stock markets and GDP growth are two bulls connected to the cart.
At times, stock markets race ahead of the GDP growth.  This happens when the fundamentals looks rosy and there is overall optimism.  In other times, stock markets remain stagnant and the GDP continues to grow.
The second case is what has happened in the last 6 years in India.  The GDP has continued to grow but the sensex has more or less remained stagnant.
“This is because markets have trailed nominal GDP growth over last five years. Sensex is up only 57% compared to the nominal GDP growth of over 100% over 2009 to 2014.”
The second aspect for equity valuation depends on the earnings growth of the companies.  At present the profit margins of companies are much below the long term averages.  With the pick up in the economy and the expected fall in interest rates, the bottom line of companies to improve significantly.   The margins are expected to expand leading to earnings growth.
“The outlook for corporate profitability is good as corporate margins are significantly below the long term averages and are expected to improve as capacity utilization and as business conditions improve. “
The third and probably the most important is the Price to Earnings multiples assigned to stocks.  The current PE multiples are below long term averages is a positive.
“Given the improving growth outlook, likely improvement in margins and the likely fall in interest rates, there is room for PE multiples to expand. 

Despite the run-up in equity markets, P/E multiples are reasonable and are still below long term averages. “

 
In the beginning of 2014, we had concerns relating to US FED QE tapering, high and sticky inflation and domestic political uncertainty.  It would have been nothing but natural to have hesitated investing in equity stocks.  At the end of year, we were in a completely different position in each of the above mentioned factors.
 
The bottom-line for the investor is that continue to invest towards long term wealth creation without trying to time the markets.

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