Short term no Long term yes

The pace of this rise has been startling. While the BSE Sensex took 535 days to travel from 6,000 to 7,000, it took just 80, 81 and 68 days, respectively, to hit the next three Rubicons. This run-up shows investors are willing to pay any price the market price asks for growth. For example, in November, analysts tracking Indian Hotels had predicted a one-year target of Rs 1,050. The stock blasted past Rs 1,300 in just 80 days.

That kind of price behaviour is influencing investors to do things they wouldn8217;t do in more ordinary times. Investors are thinking about selling, but few are turning that thought into action, as share prices keep climbing. Rather than 8216;miss out8217;, many investors are prepared to hang in there, even pump in more money than they usually would 8212; and should. In many instances, they are paying today for earnings that will materialise three to four years later.

On Friday8217;s closing of 10,110, the price-earnings PE multiple 8212; the best-known measure of stock market value 8212; of the Sensex stood at 18.6. That8217;s a far cry from where it was at its three previous peaks 8212; 25.5 in February 2000, 36.5 in April 1994 and 57.4 in April 1993 8212; but still not quite at levels where it can be said unequivocally that there is 8216;value8217; to be had, especially to the investor who is not thinking long term. The trailing PE of some Sensex stocks has tripled in the past three years. The PE on 2006-07 earnings is currently at 16.5.

8230;look8230;

The rise is backed by corporate performance. Between April 2003, when the rally began, and now, the Sensex has gained 241 per cent.

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However, during the same period, the PE of the Sensex has grown by only 46 per cent, which proves that earnings growth is a big reason for the rise. The worry, though, is: has the market risen too much, too fast, which makes a pullback inevitable?

The main reason behind this market8217;s breakneck speed is the huge amounts of money coming into it 8212; from FIIs foreign institutional investors, from domestic mutual funds new equity funds collected Rs 27,000 crore and high net worth individuals and, increasingly, from retail investors. The biggest movers, of course, are FIIs, who have made net investments purchases minus sales of about 25 billion Rs 100,000 crore in the last four calendar years. FIIs own about 23 per cent of the equity capital of the Sensex; in several companies, they would like to invest more, but can8217;t, as they have hit the investment cap.

So, on the one hand, there8217;s an abundance of buyers. On the other hand, there is, comparatively speaking, a shortage of quality stocks. Says Sanjay Sinha, fund manager, SBI Mutual Fund: 8220;New foreign investors want to enter the market, but they can do so only if the old foreign investors sell, as limits have been reached in many counters.8221;

Despite the caps on investing, foreign investors don8217;t seem to be holding back their penchant for Indian stocks. Says Andrew Holland, assistant vice president, DSP Merrill Lynch: 8220;India8217;s economic growth is expected to remain robust, which will continue to attract foreign investment.8221; Till such time as money keeps pouring into the market, in the short term, current levels can be sustained, even improved upon. Says Nilesh Shah, chief investment officer, Prudential ICICI Mutual Fund: 8220;Liquidity is driving this market.8221; That said, liquidity is too fickle a factor to be the foundation of any market or a portfolio strategy, especially in a market that is trading at or around fair value, like this one is.

Rather than swim with the flow, it8217;s a good time to pause and evaluate the investing climate. Buyers usually are willing to pay a high PE for earnings that are expected to grow at an above-average rate or are expected to be steady. Many companies that have been delivering strong earnings growth, on a quarter-on-quarter as well as on a year-on-year basis, were doing so because of higher capacity utilisation and better operating efficiencies.

Now, many of them are operating at peak capacity, which reduces the room for incremental growth. Also, higher raw material prices and utility costs, salaries and interest costs are bound to lower margins. For frontline companies, earnings growth is expected to fall from the 30 per cent of the last couple of years to a more sedate 20 per cent. During this period, it was common for analysts to up earnings estimates after companies reported excellent quarterly results. But the earnings upgrades have since reduced and, in the coming months, could reduce further.

Even if companies meet their earning targets, high PE stocks can still decline if sentiment suffers because of rising interest rates and high oil prices. Looking ahead, a combination of corporate earnings, money flows and business environment will determine the market8217;s moves. If any of these factors turn negative, it will hurt. Says Shah: 8220;The stock market is like a plant. It requires water, soil, manure and sunlight to grow. If anything is lacking, it slows down growth.8221;

8230;and go

From time to time, the market will stutter, especially in the short term, when factors like money flows and sentiment wield a greater influence over share prices. But with every increase in time period, it is performance, of the economy and companies, that will determine what happens to share prices. That8217;s what you should be looking at 8212; and buying for. In that paradigm, if you choose your investments well and give them time to play out, they will create wealth for you.

Even at Sensex levels of 10,000, there is reason to be upbeat. Just last week, the government said it expected the economy to grow at 8.1 per cent for 2005-06 8212; the third consecutive year of 7 per cent-plus growth, following 7.5 per cent in 2004-05 and 8.5 per cent in 2003-04. Analysts say investments in infrastructure and capital expenditures should help the economy grow at 8, even 9 per cent, which will trickledown to corporate profits. Says Holland: 8220;The planned infrastructure spending will boost GDP growth to higher levels. If that happens, corporate profits will improve.8221;

In the third quarter October to December, corporate performance, though not as startling as some of the previous quarters, was creditworthy: large-cap stocks market cap of

Rs 1,000 crore or more excluding oil companies recorded a net profit growth of 15 per cent, mid caps Rs 250-1000 crore 28 per cent, small caps Rs 50-250 crore 61 per cent.

India Inc too is showing more strength and promise. The service sector boom is fuelling new demand. Companies have lined up expansion plans, cut flab, invested in new technologies and are exploring new markets overseas. If you can invest in such companies at valuations that haven8217;t priced much of this expected growth, you should do well. Our package tells you where the opportunities are, and how you can create wealth, regardless of whether you are a knowledgeable investor or are just starting out. n