Rule of 72: Predicting future sensex levels

Rule of 72 deals with the layman's understanding of the power of compounding. According to this rule number of years needed to double a base figure is: 72/base figure. For example, if you have Rs. 100 today, and you expect a growth of 18% pa, then your money is expected to double in 4 years (72/18).

The BSE sensex was established in April 1979, with a base of 100. From the rule of 72 you can see that it has given a return of over 19% pa since its inception. Now let us see, whether at the current levels of 17,500 it is reasonably priced or not. The current year expected EPS of sensex stocks is likely to be Rs. 870, which can go up to Rs. 1000 in FY09. Thus, the sensex trades at a trailing PE of 20 and one year forward PE of 17.5, which is considered reasonable for a growing economy like India, expected to grow at 8.5- 9.5% over the next four years. If this is the scenario, we can expect sensex companies to grow at a reasonable 18% per annum, which is close to the long term growth of the sensex in the past. Applying the Rule of 72, the Sensex can double in 4 years (72/18) from the current levels. So we can reasonably expect the sensex to hit 35,000 levels by April 2012. Of course, some sensex companies will outperform these growth rates while some will underperform it.

Your queries:
I have received queries about the growth prospect of 2 stocks.

SBI: The stock currently trades at Rs.2100-2200, ex-rights. The rights are being offered at Rs.1590/ share, which is quite attractive. Those who do not hold the stock can buy it around Rs.1900 in a fall. It is qouting at a reasonable PE of 16, and is likely to outperform the sensex. The stock has a potential to double from the current levels of around Rs. 2000 in 3 years time, giving a reasonable annualised return of 24%.

AGRO DUTCH FOODS: The company is the largest producer and exporter of canned mushrooms. It has not got market fancy due to the lukeworm response to export units. It is growing at a reasonable level of 10% pa. The FY08 turnover is expected to be Rs. 220 cr. with a net profit of around Rs. 40 cr., giving an EPS of 12. It currently quotes at RS.38 (52 wek hi/lo of 50/24), which gives a PE of 3.2. given the current fundamentals, and the budget giving thrust to agri exports it can be bought at current levels. If the market fancy is seen towards the agri exporters post budget, this stock can double in a years time. The concern however is its low floating stock and low volumes.