Nifty: The famous five

Based on trailing twelve months earnings, the Nifty is currently trading at a price-to-earnings ratio of almost 13x. However, not all companies and consequently the sectors constituting the Nifty are commanding the same valuation.

While some are trading at a premium, others are trading at a discount.

Let us find out which are the top five sectors that are a favorite with investors these days and the likely reasons behind the same.

Software: Trading currently at a trailing 12 months P/E of 27x, the software sector commands the highest valuation and enjoys a significant lead over its closest counterpart. The rich valuations are a consequence of the robust performances of the companies in the recent past as well as their equally impressive future growth prospects.

As per the leading IT research and consultancy firm, Gartner, total worldwide IT services spending is expected to grow from $535 billion in 2002 to $727 billion by 2007, a CAGR growth of 6.3%. Also, as per NASSCOM, India's software services exports grew by 25% in FY04, from $9.6 billion to $12.5 billion.

This represents a mere 1.6% of the global IT services market. NASSCOM also expects Indian IT services exports to cross the $56 billion mark by FY08, which would mean CAGR of over 45% in the four-year period (FY04-FY08).

Both these factors combine to signal Indian software sector's huge growth potential going forward. No wonder then that this sector has become the blue-eyed boy of the Indian stock market.

Engineering: Awash with funds, most of the companies in the Indian corporate sector have embarked upon an expansion spree in recent times. According to a leading business daily, corporate India added fixed assets worth Rs 334 billion in FY04, a significant 33% growth than the previous year and it is not done yet.

In fact, India Inc could be heading for its first major capacity creation spree since the now infamous binge of mid-nineties. Investments on such a large scale would mean swelling order books for engineering companies, as they would be called upon to execute the projects.

As a consequence, engineering sector is ranked second currently in the valuations sweepstakes as they might see their earnings growing significantly in wake of the new capacity creation that is underway.

Telecom: With a population of over a billion and teledensity of merely 4 to 5 per 100 people, there is an enormous growth opportunity to grow for the Indian telecom companies.

Therefore, a valuation of 21x that is being commanded by these companies does not come as a surprise. In fact a chunk of it is due to the presence of Bharti Televentures, India's leading cellular player. However, going forward there are some concerns. While the growth in subscriber base is expected to remain robust (over 100% growth in cellular subscriber base), it is the falling ARPUs (Average Revenue Per User) that have started to bite the cellular companies.

The result is diminishing margins and falling profitability. But over the long-term, price-based competition is unlikely to persist and the quality of service is likely to emerge as a key differentiator.

Moreover, while the sector per se would show impressive growth numbers in the times to come, the going may not be that easy for small individual players.

Pharma: Armed with a rather liberal process patent policy and availability of low cost manpower, Indian pharma industry has grown at a tremendous rate in the past few years and is now making its presence felt in the global arena.

With pressure on the US government to reduce healthcare costs, it has passed regulations to speed up approval procedure for generic drugs, a market which is expected to touch $100 billion by 2012.

This is a great opportunity for Indian drug manufacturers to exploit, as the cost of production in India is low as compared to the West. The domestic market is not faring badly either and is expected to provide further fillip to the sector companies. On account of these reasons, the sector currently commands a valuation in the region of 21x.

Power:Rounding up the list is the power sector that currently enjoys valuation in the region of 18x. Power is one of the most important vehicles of infrastructure that can help a country achieve higher economic growth.

Recognising the importance of power, the government has set an ambitious target of increasing the per capita consumption to 1,000 units by 2012, which is almost three times the current level.

The 10th Plan set a target to add 41,110 MW of generation capacity by 2007. Considering the track record, even if 50% of the above-mentioned capacity is achieved, it will result into a spectacular growth opportunity for the sector companies. However, power projects are long gestation projects and benefits only accrue in the long term. Therefore patience is an important virtue here.

Having looked at the top five sectors in terms of valuations, we would like to advice investors that rather than putting all eggs in one basket, they would do well to diversify and allocate their investments across different sectors. This will shield them from the vagaries of the stock market. After all, diversification is the key to successful investing.

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