Media focuses way too much on the movement of Nifty 50 index. In the recent past Nifty 50 has been mounting up without the support of fundamentals. Is it a true barometer for the Indian economy?
Let’s try and understand what is happening in Nifty 50.
The Nifty 50 is a flagship benchmark index on the National Stock Exchange of India Ltd (NSE), which comprises of the top 50 companies in terms of free-float market capitalization (essentially the count of shares in active circulation in the market at any given point of time). It is a well-diversified index, with companies from 13 sectors such as financial services, energy, IT, automobile, metals, media and entertainment etc.
Source: www1.nseindia.com
Evaluating and analyzing the Nifty 50 can give reasonably reliable results on whether the overall economy is doing good or not.
But does only viewing the numbers of Nifty go up and down tell us all that we need to know?
As is the case with most things related to analysis, it doesn’t. The numbers can even be misleading. Any economist will tell you that if only the extremes are pulling the numbers up and the majority of companies are in bad shape, then the numbers are going up only technically and the true overview is much different.
Therefore, we need to analyze the index on other factors as well. The question, is Nifty expensive, can be answered by looking at the price to equity ratio.
What is Price to Earnings (P/E) ratio?
Price to Earnings ratio is the current market price per share divided by the earnings per share. In terms of the Nifty index, the PE ratio indicates its overall expensiveness or cheapness with regards to its earnings.
Through these factors, we can learn if the markets are historically cheap or expensive and make certain investment decisions.
Given below is the quarterly PE ratio of Nifty over two decades, from 1999. The overall average PE ratio over this time is around 20.
As we can see from the above tables, the PE ratio in the previous 5 years (2015-19) has been above 20, with the PE reaching an all-time high of 29.07 times in 2019’s second quarter. It has been above 25 from 2017’s Q2 all through 2018 and 2019.
The high numbers in the PE ratio indicate that overall, the markets have been priced at 25-29 times their earnings and that Nifty is indeed valued dearly.
Nifty is currently one of the most expensively valued global equity indices among its emerging market peers. The MSCI Emerging Market index’s P/E is at 15.02 times. The MSCI shows large and mid-cap stocks from among 26 emerging countries.
Media often quotes that huge money is being invested by foreign investors (FIIs) in India. That money is often invested only in Nifty 50 companies, making Nifty 50's PE even more expensive.
Most of the emerging economies are struggling to grow their GDP's. India's growth has also slowed but still it is the second fastest growing economy in the world. Due to this, FIIs have been pouring money in India.
This is responsible for making Nifty 50 quite expensive and the high value may not be correlated with the underlying growth in the Indian economy.
At this time, the large-cap category may be completely avoided or a basket of only high-quality stocks should be created. Quality stocks may be extremely expensive too making the return expectations more muted over short to medium-term horizon.
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Advisor: Ankur Kapur
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