Should you invest in stocks now?

Now that everyone on the Dalal Street is 'revising' the target for the benchmark BSE-30 upwards, especially after a good Budget, the premise of the same has to be questioned.

Yes, the benchmark index is trading at an estimated price to earnings (P/E) multiple of 14 times FY06 earnings. But, is it 'good enough' for one to be bullish?

In our post-Budget analysis, we had mentioned that one of the key comfort factors with respect to investing in stocks stems from the fact that the Sensex is trading at a P/E multiple of 14 times FY06 estimated earnings (though with an upside, considering the lowering of the tax rate).

With earnings growth visibility at over 15% per annum, there is a strong case for equities, even at the current juncture.

But if one were to take a look at the valuations level across sectors and the commensurate return over the next two to three years, equities are 'not' that compelling as the broader numbers suggest.

Take for instance, the steel sector. Yes, the valuations of steel stocks are at 7 times to 8 times FY06 estimated earnings, which is in line with the long-term growth prospects.

But considering the fact that the steel cycle is 'close to the peak' (which means that prices of goods are at the highest and therefore earnings are robust), valuations do tend to look 'cheaper'. But what if the steel cycle weakens?

Let us take the case of the auto sector. Most of the auto stocks are trading at well over 12 times our FY06 estimated earnings and based on consensus, the multiple lowers to around 10 times (for some stocks).

At a P/E multiple of 10 times, yes, there seem to be an upside. But what are the risks? Why is it only 10 times when 'everyone' is looking at buying cars! The key risk, in our view is the margin pressure on auto companies, which the 'consensus' has seemingly not factored in adequately.

Expecting Tata Motors to grow commercial vehicle sales 'only' by 12% in FY06 as against 32% in FY05 may seem conservative, but it means that the company has to sell more than 150,000, which is no joke.

We also expect the passenger car industry to grow by 15% per annum and Maruti to maintain market share and operating margins at well over 12% level (among the highest globally), even when there is one new model introduction a week in the markets by industry players.

It is not that we are negative on the stock market. But we suggest investors to tone down expectations and keep a track of the downside (read risks) before making their investment decision.

As far as mid-caps are concerned, we would like to quote Jack Welch here; "When you're number four or five in a market, when number one sneezes, you get pneumonia." What applies to Gujarat Ambuja or ACC also impacts Mangalam Cement and Prism Cement.

So, where should one invest in equities? Here is our effort to simplify for retail investors. We have prepared a matrix of various sectors and have tabulated them on the basis of our risk and return expectations.

We have considered various factors like sector dynamics, the quality of managements in each of sectors, valuations and susceptibility to downturns. Obviously, this is with a three-year investment horizon.

Our sector allocation mix for. . .

Key points to remember:

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