Valuations of most sectors have jumped substantially during the past financial year, but operating growth has failed to justify the rise

During the financial year 2009-10, several sectors of the economy rebounded from the downturn brought about by the financial crisis of 2008. While this recovery was mostly tentative, stock markets responded with typical vigour and optimism, sending valuations of companies soaring.

But has this surge in valuation been justified by the growth exhibited by the various industries? Not quite-which should be an object lesson for those who believe in trying to find a close correlation between corporate fundamentals and market prices.

Take for instance, the retail sector, which was one of the worst-affected during the downturn, and is still picking up the pieces. Between March 2009 and March 2010, the sector has seen its market valuation surge dramatically. It is now valued at 75 times its annualised operating profit, while actual growth in operating profit has shrunk by 45% during the same period.

The telecom sector has also become expensive, with a valuation of 25 times annualised operating profit. Although its market capitalisation has remained flat between March 2009 and 2010, a 66% reduction in operating profit growth during the last financial year has skewed its valuation unfavourably.

The sugar industry has also fallen on rough times, after a meteoric rise in valuations barely until six months ago. With sugar prices receding dramatically, operating profits have fallen 25% during financial year 2009-10. Sector valuation, on the other hand, still remains high at six times annualised operating profit.
Other sectors that didn't record growth sufficient to justify high valuations were petrochemicals, office equipment, plastics, engineering, software and IT services.

The petrochemicals industry saw an operating profit growth of just 3% in the last financial year, yet its valuations jumped 107%. Similarly, office equipments and plastics industries recorded growth in operating profit of 16% and 14% respectively, while their valuations belied the growth, rising by 98% and 131% respectively. The engineering-electricals-electronics industry turned in a reduction in operating profit by 2% during the year. Despite this, valuations soared 113% during the same period.

On the other hand, some sectors where operating profit growth has justified growth in valuations are auto components, chemicals, paints, paper and paper products, steel products, textiles, lifestyle and leisure. The auto components industry has ridden piggyback on the revived demand for automobiles, reporting a rise in operating profit of 75%. Similarly, steel products, chemicals and paper & paper products industries have shown robust performance, with operating profit growth of 144%, 75%, and 46% respectively. However, valuations still remain attractive at 4.2 times, 5 times and 2.4 times annualised operating profit respectively. The textiles, lifestyle and leisure industries are also in the same boat, having registered operating growth of 136% and 109% respectively. Their valuations have captured this growth nicely, with a 22% rise each during the last financial year.

Other sectors have witnessed their valuations declining despite some strong financial results during the year. The valuation of the real-estate sector has come down heavily (97%) despite a massive 7,155% jump in operating profit growth over the year. Pharmaceutical companies also reported a robust 120% growth in operating profits during the year, yet their valuations have not supported the growth, falling by 7% during the year. The oil & gas sector's valuation too has not moved along with its growth. The sector grew 60% in terms of operating profit in the last financial year, while valuations declined 6%.