It's widely known that the stock market is driven by sentiments in the short term. This fact is corroborated by the companies listed below. These companies are constituents of the BSE SmallCap index. They have gone up at an annual rate of 50 per cent or more in spite of slow annualised growth in earnings of 5 per cent or less.
What has caused this euphoria? One obvious factor is the ongoing bull phase. In a bull market, investors frequently ignore negative news and fall over each other to put money into the market. Nobody wants to miss the bus.
Some of the stocks mentioned below have gone up due to positive tailwinds. For instance, Escorts has gained due to good tractor sales but its P/E has also expanded from 20 to 63 over three years. In order to maintain such aggressive valuations, the company has to post robust profits in the future.
Look at Indiabulls Ventures now. This stock has gone up along with other Indiabulls companies, with no clear reason in sight. It has even come under SEBI's scrutiny.
Such euphoria doesn't last long as stock prices are bound to follow fundamentals in the long run. When overpriced stocks correct from the peak, they destroy all the wealth that they had created. And this happens so quickly that most investors who had been grinning are caught off guard. Investors should stay away from companies with stretched valuations unless they are fundamentally sound and the future EPS growth can justify current valuations. Otherwise, any bad news can lead to severe wealth destruction.