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STOCK MARKET

A pricey investment?

Sarwar A Chowdhury
At the end of May 2008, the price-earning (PE) ratio of Eastern Lubricants stock stood at over 366. That means if you had bought a share it would take 366 years before the company earned enough profits to equal the value of your investment.
Eastern Lubricants, a state controlled lubricant blender, may be an extreme case, but it is not alone on the Dhaka Stock Exchange (DSE) in having a high PE ratio. In one case the PE ratio is over 600.
A PE ratio is a company's current share price compared to its earnings per share. In general a high PE ratio reflects that investors are expecting higher earnings in the future or that there is a strong chance that they will be able to make a capital gain in the stock. In other words that the value of the share will increase and the investor will be able to sell it for more than he paid for it.
What is of more concern for many investors however, is not the peculiarities of individual stocks, but the average PE ratio for the DSE as a whole. This ratio stood at around 25 in May, a historically high level and evidence for some that the market is now overpriced and that a correction is on its way.
The market PE ratio started its upward trend in April last year when the ratio was 15.03. It crossed the 20 point mark in August last year and touched the 23 point mark in
November.
Certainly if you look at the Bangladeshi market in relation to others in the region there is cause for some concern. Although it is difficult to draw direct comparisons as Dhaka's PE ratio is based on historical earnings rather than earnings forecasts, the indication are that Dhaka is expensive. For example, the average PE ratio in Pakistan is around 14, in India 22, China 19.5andThailand 14.
"The PE ratio basically indicates that the stock market is overpriced,” said one cautious investor.
The reasons given behind the sharp rise in stock prices and the fact that the rise has
become decoupled from earnings depend on who you talk to. Bullish investors say that with so much liquidity in the market and with so few stocks to invest in current price are sustainable. Indeed, they say that simple supply and demand will push prices higher.
The market is expanding gradually, but the supply side remains poor in comparison with the growing demand of investors, they say
The bears say the market is simply being driven by retail investors chasing rumours and that sooner or later market fundamentals will force a correction or worse, a crash.
Yawer Sayeed, managing
director and chief executive officer of AIMS of Bangladesh, says the PE ratio shows how much the market is overpriced.
“There are so many investors in the market, but there is not an adequate supply of securities to meet the investors' demand," he said.
Presently, about 15 lakh beneficiary owners (BO) accounts, the kind of account needed for trading, are active in the stock market. In effect this means 15 lakh investors.
At the end of May, the total number of listed securities on the stock exchanges stood at 378, of which 271 are companies, 14 mutual funds, eight debentures, 84 treasury
bonds and one corporate bond. Total market valuation was Tk 88,194 crore at the end of May, almost double the level a year earlier.
A high market PE ratio creates more risk to the investors especially to the marginal ones, DSE Chief Executive Officer Salahuddin Ahmed Khan said recently.
"Usually market price earning ratio at 14 to 15 reflects a sound capital market," he said, adding that the investors should invest more cautiously.
Talking to The Daily Star, Faruq Ahmad Siddiqi, chairman of Securities and Exchange Commission, said the PE ratio is little high, but it
had stabilised during recent months.
“So, it is not alarming at the moment. The question will it be sustainable at the same level in future?” he questioned. 4
Several market experts feel that rolling out more products to broaden investors' options as to where to put their money is the major way to cut the PE ratio as well as cool down the market.
“The market needs more new securities to meet the huge demand for quality shares since investors have enough liquidity in their hands,” Yawer said.
sarwar@thedailystar.net