Nifty Is Not Really Overvalued: Report
Moneylife Digital Team 21 January 2021
After the onslaught of COVID-19 earlier this year when everyone was expecting the stock market to fall further, it not only rallied but have also touched new highs. The market rally against the backdrop of a gloomy business outlook, however, has raised concerns of extremely high valuations of Nifty stocks. Nifty price-to-earning (P/E) ratio has hit an unprecedented 30+. 
 
According to a recent report by ICICI Direct Research, the Nifty P/E is at 32.8 (based on FY19-20 earnings per share—EPS) and trailing-12-month (TTM) P/E is at 38.5. Usually, Nifty trading above a P/E of 25 is a sign of concern and is considered an expensive market or the market is said to have run ahead of fundamentals. So, what does the current market valuation tell us?
 
The ICICI Direct report spells out that P/E multiple should not be looked in isolation as the TTM P/E might be high as first quarter (Q1) of FY20-21 and second quarter (Q2) of FY20-21 were a washout quarter due to Covid-19 and markets are expecting better future earnings. 
 
It also expects P/E for the benchmark index to shift to higher orbits as the constituents of Nifty have changed in the past decade and dominated by capital-efficient sectors such as fast-moving consumer goods (FMCG), financials services, information technology (IT) and pharma. As these sectors have consistent and predictable earnings, the Nifty P/E needs to shift to higher orbits, the report says.
 
Source: ICICI Direct Research
 
During the past decade, weightages of sector such as financials, FMCG, IT, pharma have gone up as is evident from the table above, while weightages of sectors like oil & gas, construction, metals and telecom have reduced. 
 
According to the report, such changes logically shift the P/E orbit higher as well. Heavyweight sectors have already performed well during first half (H1) of FY20-21 and recovery in demand will lead to better earnings in FY22-23. Cyclical sectors will also see a cyclical upturn and hence will exhibit better earnings in FY22-23, ICICI Direct says, adding expectation of better earnings is also one of the reasons mentioned in the report as reason for a higher P/E.
 
Another reason for high P/E as per the report is that there are nine companies, which have a weightage of 32% in Nifty. Their valuations are based on sum of the parts (SoTP) methodology as these companies have diversification across sectors and, hence each business need to be valued using a different method. So in such a situation looking at a Nifty P/E on a standalone basis is not effective since many companies have businesses, which are fast growing than the core business and hence attract higher P/E multiple, the report adds. 
 
Using a bottom-up approach of weighted average P/E of all individual companies of Nifty based on the expected earnings performance and individual target prices assigned for each stock, it has arrived at a forward P/E of 26.2 based on FY22-23 EPS of Rs740. To account for any unforeseen risk in the future which might impact earnings it has discounted 10%-15% its weighted average P/E and after discounting the target P/E multiple comes to 22-23.6 times. Based on this multiple, the fair value of Nifty, as per the ICICI Direct report, comes to 16,300.     
 
Comments
shetyerb
2 years ago
Apart from all above analysis we must also consider the foreign institutional investment on large scale.
Two main reasons. One No more investment in China and 2, near zero interest earning in their own country.

rahuljain.5192
2 years ago
Valuations are not really high!
- Said the brokerages before each major crash.


Doesn't mean that a crash is due. Just that brokerages opinion can't be relied upon.
Ashish Bal Dikshit
2 years ago
Cant read full article. Some problem with the aap.
Ramesh Popat
2 years ago
so khelo India khelo! but expect the unexpected soon!
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