The target for the Sensex has been rising with the soaring seat forecasts for the NDA.

There is now free talk of the BSE benchmark hitting 30,000 and 40,000.

But is this realistic?

What will it take for the Sensex to hit these targets?

At 22,800, the Sensex today trades at 15.6 times its estimated earnings for 2014-15. This, many market participants believe, is its ‘fair value’ because this is the average PE (price earnings) at which the Indian market has traded over the last 10 years.

Profit factor

If the Sensex continues at these multiples and yet needs to hit 30,000 within a year, it is the denominator — corporate profit — that has to expand.

Can we not have this kind of growth?

Maybe, but to spot the opportunities a sector-wise analysis may help.

Banking

Take banking stocks, which account for a fourth of the Sensex, by weight.

The stocks rallied, but profits were flat in the first nine months of 2013-14.

To lift the Sensex to 30k, this sector must grow 30 per cent plus this fiscal.

But even if a Modi-led government does announce reforms, kick-start infrastructure projects, help companies de-leverage, and stem bad loans, banks will benefit only when the projects actually begin to earn. At best, therefore, profits in this sector can grow 15-16 per cent in 2014-15 and 18-20 per cent in the following year.

Capital goods

The other beaten-down sector on which investors are pinning hope is capital goods. The combined profits of companies in this sector plunged 21 per cent in the first nine months of 2013-14.

This sector, which supplies equipment and services to other industries, can see order flows revive if companies begin to invest in new projects. Yet, it would be unrealistic to expect the sector’s profits to grow over 40 per cent, as happened during its heyday pre-2008.

At best, profits can grow 20 per cent the next two years as the investment cycle recovers.

Earnings of companies in the oil and gas sector (14 per cent weight in the Sensex) grew 4 per cent annually the last five years.

Declining output and the overhang of subsidies have left the sector in bad shape. Unless these issues are tackled, growth pick-up is unlikely.

The ‘Defensives’

There are then the defensive sectors, pharma (5.7 per cent weight) and FMCG (14.5 per cent), which are already trading at stiff PEs, based on their good profit growth the last five years. For them to do better is difficult.

That leaves IT companies (17 per cent weight), which may grow faster this year, going by the stronger global IT spending. But this may not be enough to translate into 50 per cent growth for the Sensex.

Optimists may point out that bull runs are seldom about fundamentals. Usually, the market PE shoots up first hoping corporate profits will catch up. By this argument, the Sensex can surely rise some more. The bull runs of 1999-2000 and 2007-08 halted only after the Sensex PE shot up to 22 times or thereabouts.

Assuming a moderate — 15 per cent — growth in corporate profits this fiscal and applying a PE of 22 timesto that number, throws up a Sensex of about 31,900. But be warned, this is merely crystal-ball gazing.

In the last 15 years, every big market crash happened after the Sensex soared to a PE of over 20.

comment COMMENT NOW