Thread by @hktg13

Seeing quite a few posts on record high P/E ratios etc of Indian equities. Small theoretical exercise to potentially highlight the optical nature of a ratio like trailing P/E ratio especially in context of a massive shock like Covid

Assume a 2 stock index, company A which is generally been a compounder & has a resilient biz model and company B which was barely growing and vulnerable to shocks (either high fixed costs or high debt)

Come the lockdown in March,A sees a sequential decline in profits,from June qtr & Sep qtr, YoY growth slowdown is even more sharper,bfr stabilising in Dec qtr & given low base of Mar 20,Mar 21 qtr YoY surges. Growth for year FY21 is at 17% compared to 20% it achieved pre-covid

Company B has no such luck given its vulnerable biz model,profits half in Mar20 & it swings to losses in June and Sep qtr, bfr finding its feet in Dec qtr & then growing significantly in Mar21. Overall growth for FY21 is at negative 74% compared to 5% growth it achieved pre-covid

To calculate P/E ratio, trailing 4 qtr profits are computed, each time qtrly result comes, the previous year qtr result is dropped and latest one added etc. From a peak combined profit of A+B of 112 in Dec 19, it plummets to 68 in June 20, before sequentially improving thereafter

However, from a trailing 4 qtr combined profit pool, worst number is in Sep-20 (347) and Dec-20 (350), compared to 431 in Dec-19, before coming back to 400 levels in Mar 21, an overall drop of 5% for FY21 for the index, an arguably good achievement given the overall backdrop

Now assuming a flat index level (market cap of 12000),from Dec 19 to Mar 21, this huge swing in TTM EPS of index (even as overall EPS for FY21 is down only 5% compared to FY20), P/E varies from 27.84 in Dec-19 to 34.58 by Sep-20, almost 25% inflation in PE ratio from Dec19 levels

Also, even as worst qtrly print say of June is behind, PE keeps getting revised up as more profitable back qtrs of FY20 get replaced by latest results.Also as one moves to June - Sep 21,reverse impact will be seen as PE ratios shrink as poorer qtr prints keep getting updated!

To sum up, purely focusing on one data point of PE ratio etc for asset allocation may potentially bring in a lot of noise. The above eg is purely a theoretical exercise to explain huge potential swings we will see further in the year in the widely tracked PE ratios.

This is not to justify that markets are cheap or one should throw the PE ratio to bin etc, but to reflect to remove the noise from the signal that this series carries!

& lastly, PE ratio put out by NSE etc which are generally fwded in abundance in most whatsapp/telegram groups are standalone P/E ratios and not consolidated P/E ratios

FIN!

assetmanagement.kotak.com/documents/19/d…

Few of these quirks explained in this note on Kotak Balanced Advantage Fund, which uses valuation and sentiment gauge to arrive at asset allocation