27 October 2009
Making sense of the Market thro’
Sensex@MRP
MRP is the maximum price one should
pay for the stock.
Minimum Expected Rate of return when
you invest in stocks should be 15%
CAGR.
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The BSE Sensex is the barometer of the mood of the Indian stock
market. From a Jan 2008 high of 21,000, it touched a low of 7,697 in
October 2008. Now in October 2009, 1 year later, we are around
17,000.
There is much debate, lots of opinions being expressed on TV, in the
pink papers, in the Internet on: Are these levels justified? Is the Sensex
due for a correction? Where will the Sensex be by the year-end and
the next year?
In this report, we suggest a way to ‘Make sense of the Market’ thro’ a
concept that we as consumers are all familiar with: MRP- Maximum
Retail Price. When we go to buy a soap, a shirt, a chocolate we look at
the MRP. Don’t we wish our stocks come with an MRP marked on
them? At Moneyworks4me.com we have done precisely this. Let’s
see how.
What should be the basis of calculating the MRP of a stock? The
maximum price that an investor should be willing to pay for a stock
today depends on the return on the investment that he expects when
he sells the stock in the future. When you invest in stock markets you
are taking on additional risk which you would avoid if you invested in
say bank Fixed Deposits. Hence while calculating the MRP, we have
taken a Minimum Expected Rate of Return of 15% CAGR.
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 Making Sense of the Market thro’ Sensex@MRP
The Sensex @ MRP indicates the point
beyond which markets are driven more
by liquidity and irrational expectations.
How do you calculate MRP?
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The next challenge is: How do you estimate the future price of the
stock? Here we are guided by what Benjamin Graham has said about
the stock market. He said that in the short term the stock market is like a
voting machine and in the long term it acts like a weighing machine.
What this means is that the future price of the stock, in the long term
depends on the real worth of the stock i.e. its ability to generate
earnings per share, EPS. Thus as a savvy investor, you must track the
EPS growth rate of the company you are investing in. This will enable
you to estimate the future EPS of the stock.
At Moneyworks4me.com, we have computed the MRP of all the
listed stocks after a thorough analysis of the companies, their
financial track records and their future growth prospects.
So how do we find at what level the Sensex is sensible?
Considering that the Sensex stocks are the top traded stocks of the
country, we can expect them to be traded at their MRPs. So let’s see if
we can make sense of this “barometer of the Indian Stock Markets”
and arrive at an indication of whether the Sensex is fairly valued or
whether irrationality is driving the markets.
The obvious method is to find out at what price should each of the
Sensex 30 stocks trade at, i.e. their MRP. We can then plug in these
prices and check out what could be considered as a sensible level for
the Sensex. We like to call it Sensex@MRP.
The free float market capitalization at the MRP of the individual stocks
as computed by us at Moneyworks4me.com and share data as on 14th
Oct 2009 is Rs.1,323,663 Crore. Using the index divisor 74.42 (as on
14th Oct) the Sensex@MRP is 17,786.
Sensex@MRP Calculation:
Free Float Mkt. Cap. using MRP 1,323,663
Index Divisor 74.42
Sensex @MRP 17,786
Factoring an estimated 15% increase for the September quarter
earnings (YOY) of the Sensex companies, the Sensex@MRP goes up
by 691 points to 18,477.
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 Making Sense of the Market thro’ Sensex@MRP
Any bad news can trigger a sell off and a
correction.
Sell stocks which have crossed their
MRP and buy only with a Margin of
Safety.
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So what does the Sensex@MRP tell us? Should we be buying or
selling? Isn’t this the question being asked often? What we can
definitely conclude is that the market is approaching its outer
limits. This is certainly not the time to buy stocks without looking
at valuations and hope that another bull run will happen. Any bad
news can trigger a sell off and a correction. It’s not that all the
problems of the past are over and we are on a fundamentally
strong wicket. It is just the increased liquidity that has attracted
money into the market.
Here is what we recommend you do: The real question you should
ask yourself is: Should you be willing to buy stocks at their MRP? At
MRP you can expect to get a 15% return on your investment. But have
you factored in a Margin of Safety as the guru Benjamin Graham
insists on doing? No you haven’t! This is crucial as you should be
selling stocks which have crossed their MRP and buying only with a
Margin of Safety.
As wise investors you should sell off stocks which are trading
way above their MRP and you have already made handsome
gains. Similarly if you have invested in mutual funds, review their
performance and consider starting to sell. Use the money if you
need to or just park it and wait for a correction. If you strongly
believe a significant correction is unlikely to happen and wish to
remain invested in stocks, do so only in select stocks trading
close to their Discounted Price (half of MRP). Only a few good
stocks are now available at less than Discounted Price.
We believe the Sensex around 18,000 indicates the level beyond
which the markets may be driven more by liquidity and irrational
expectations about the future.
Have we been cautious or aggressive when predicting the future EPS
and P/E? Maybe we have been a tad cautious. The MRP is based on
the latest TTM EPS, so if you expect an increase of 10% in the EPS in
the next few quarters shouldn’t the Sensex touch 19,500. Maybe it will,
considering that there is too much of good news floating around in the
media. Maybe the market has already factored that in. Maybe it will fall
if the FIIs decide to book their profits and take their money someplace
else. But then all these ‘may-bes’ make it a gamble. Is that what you
want to do?
Equity Analyst: Nikhil Kale
nikhil.kale@moneyworks4me.com
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 Making Sense of the Market thro’ Sensex@MRP

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