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Suresh Krishnamurthy

JUST a week ago, the stock market was on a roll. But it has since slowed. Is this a mere correction? Will the Sensex soar again after a brief pause? Or has the end of the road been reached? The last could well be the case. At least, that is what a perusal of the analyst reports of major research outfits suggests.

If analyst reports are taken at face value, the potential for upside may be limited to about 5 per cent for the Sensex. For a broader mix of 70 stocks, the cumulative potential upside is less than one per cent.

This is the message that emerges when the price targets mentioned in these analyst reports are aggregated. The 70 stocks account for just over 60 per cent of the market capitalisation now.

Influential sections of the market believe that a large segment of the listed stock universe is now at close to fully valued levels. Analysis done a few weeks ago indicated that the price-earnings multiples of stocks are now marginally higher than their expected one-year growth rates — a simple way of determining the state of valuation.

That, again, suggested that the valuations have substantially factored in earnings growth prospects. Clearly, putting fresh money into stocks in anticipation of large, outsized returns needs a strong appetite for risk now.

Sensex: Low upside

For the analysis, research reports of global outfits such as UBS, Salomon Smith Barney, Merrill Lynch, CSFB, Deutsche Bank and Morgan Stanley were considered. This was done because foreign institutional investor (FII) money is now the prime moving force for stock prices. FIIs have invested close to $2.4 billion over the past four months.

Where reports of these outfits were not available, reports of Indian firms such as Motilal Oswal, SSKI and ICICI Securities were considered.

In almost all cases, only the recent reports were considered. Of the 70 stocks for which such reports were available, the reports were dated July for only nine companies. For the others, the reports were released either in August or September.

To determine the potential for upside, the market capitalisation of the Sensex was calculated based on the price targets mentioned in the reports. If more than one research report was available, the higher price target was considered.

The calculations revealed that the market capitalisation of the Sensex based on price targets were higher by just 4 per cent over the present market capitalisation. In other words, the expected Sensex upside is only 4 per cent in the near term.

Price targets were not available for the stocks of Reliance Industries, Hero Honda and HPCL, among Sensex stocks. The non-availability of price target for Hero Honda is not a major issue as analysts had given a sell recommendation, and the market price is now higher than the price at which the sell was given. Non-availability of price target for HPCL is also not a major issue as the stock is expected to settle at lower levels in the absence of disinvestments.

The only issue is Reliance. However, even if Reliance's price target were higher by 20 per cent from present levels, the Sensex upside would still be less than 7 per cent. Interestingly, 11 of the Sensex stocks are trading at prices higher than the target price, with the other seven trading closer to the target price.

Relatively larger potential for upside was seen only in stocks such as SBI, ACC, MTNL, Nestle and Ranbaxy. HLL, Infosys Technologies and Gujarat Ambuja were trading at prices that were 10-15 per cent below the price targets.

Large caps on a high

The analysis predominantly covered stocks with a market cap of more than Rs 2,000 crore. Of the 70 stocks, 50 had a market cap of more than Rs 2,000 crore.

Interestingly, the other 20 had a higher potential for upside compared to these 50 stocks. The gap between current market price and price target is about 20 per cent for stocks with a market cap of less than Rs 2,000 crore.

This indicates that the valuation of mid-caps and small-caps are relatively lower than those of large-cap stocks. This suggests that the former may outperform the latter in the next 12 months.

Some mid-cap stocks that are trading at prices much below the target price are Arvind Mills, Indian Rayon, Raymond and Aurobindo Pharma.

The gap between current market price and target price is more than 50 per cent. Outside of Sensex, Asian Paints and ABB were seen as having upsides of more than 20 per cent.

Large-cap stocks that were trading at prices far ahead of their price targets were TVS Motor, Hindalco, BHEL and Gas Authority. And their mid-cap counterparts were TNPL, Jammu and Kashmir Bank, Polaris Software and Hughes Software.

Fully-valued to over-valued

The ruling market prices of stocks and their relation to target prices fixed by research outfits question the wisdom of putting fresh money into the market now in anticipation of large returns.

However, this may not mean the end of the road just yet. Further upgrades of earnings growth prospects are possible. That may yet lead to large returns.

In addition, these institutions represent only one section of the market. There might just be another section that believes that the potential for upside is higher. If this section backs their views with the right kind of money, stock prices could indeed soar again.

Another aspect to be considered is that bull runs often culminate in excesses. So, the present correction could be followed by a bull run that could transform the present fully valued market to an over-valued one in the next few months.

Potential promise

Still, there are sectors that might still hold potential. For example, the mid-cap healthcare stocks might still surprise you. Analyst reports indicate that the earnings growth of these stocks may accelerate beyond March 2004. The target price for one such stock, Aurobindo Pharma, is Rs 1,000, while the ruling market price is Rs 600.

Another sector that can surprise investors is banking. Analyst reports have uniformly pegged the target prices of banking stocks, barring SBI, at levels much below their prevailing market prices.

However, triggers such as improved coverage for bad loans, lower interest rates, return of capital to Government and rising spreads might lead to sustained upturn in valuation of banking company stocks.

Pointers towards caution

Still, the small gap between target prices and the current market prices advises caution for retail investors. Some valuable suggestions that the ruling market valuations dictate are:

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Large-caps: From a bang to a whimper

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