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Charts & Analysis

The Nifty Has Fallen, But the P/E Ratio is at a Relatively High 20 While Earnings Contract

Just as the market breaks into a low, we revisit the price-to-earnings chart of the Nifty. Earnings are falling – by more than 5% over last year at this moment – and the P/E of the Nifty continues to be as high as 20, even after this fall.

Nifty PE

How can P/E and earnings growth diverge for too long? we’ve been on a diverging road since 2009. If corporate earnings have fallen off a cliff (and they have) then we should be falling – and we have only fallen to these levels. Fundamentally, if we were to see a P/E of just 18, that is another 10% fall from here at least. Just putting some perspective.

The stuff yet to come: The rate hike in the US, the lousy corporate earnings in the Dec quarter, the fight over GST, and the NPAs and Defaults. The next few months will be fun!

  • Gold Bug says:

    As long as interest rates are low, retirees/pension funds in US, Europe and Japan will not move away from some risk assets. So P/E of 20 seems OK for them.

  • Suresh VR says:

    Hi deepak, is this the standalone pe or consolidated pe?

  • Saurabh Mittal says:

    Hi thanks for this great analysis. Can you also post a chart of P/e multiple as compared to actual EPS instead of YOY growth.

  • Karthikraja says:

    Good Low base effect formed and still forming. Selective stocks which fell eavily due to Dec 2014 results will make a swing…..

  • shashankjogi says:

    Hi Deepak.
    It may not completely correct to look at a PE ratio (or such simplistic ratios) and conclude whether the index if cheap or not. If one has to look only at such very simpistic ratios, then the Price to Book Value of the Nifty stands at 3.06 (was at 3.38 when the Nifty was at 6600 before the Modi rally in May 2014) and that of the BSE Sensex is at 2.59 (Sensex PBV was 2.6 on 1 Nov 2008 after the big crash in Oct 2008). Does it mean that on the Sensex we are at the same valuations today as we were on 1 Nov 2008 as the PBV might suggest? Not at all!
    Ratios such as PE and PBV and the like are very approximate, just good enough to sometimes figure out gross overvaluation or gross undervaluation, but not much beyond that. The current ROE of the Nifty (free float market cap weighted) is 22%. That is an attractive ROE (again simplistically put, debt levels not withstanding). The thing is that Nifty is not over valued just because earnings growth has been very low (even negative) and PE is at 20 or just because PEG is way high…this is impacted by cyclically low earnings growth. Historical PE comparisons have limited meaning because the index composition, the ROE implicit by index constituents, the quality of stocks that comprise the index now, the methodology used for calculating the index, even the level of ‘normal’ interest rates have all changed. To use one single brush of PE or PEG is being too simplistic.
    This is not to say that the index cannot go down. It surely can and that would not be surprising…But that even at Nifty 7000, the PE would be still a ‘high’ 18 (and therefore not attracive) may be misleading. One needs to go much further into our analysis before we can make such conclusions.

    • While your points are taken, I have a few counters. 1) I don’t believe in the price to book ratio – largely because companies overreport their book (specially banks).
      2) P/E is a good indicator over the longer term – the constituent thing etc works itself ove time. The PEG or earnings growth number to me is important as a factor of whether you are overpaying for a business or index. If you are, youre just trading, and that’s fine but don’t crib when the markets fall because they were always bubbly. I am happy to be a trader in a market like that – I will trade momentum through and through. But it’s not surprising that the market will fall to p/e levels that are more sustainable!
      3) ROE is not a valuation metric. It is purely a metric that tells you if a current company (or in this case a set of companies) are using capital efficiently. You can pay X for a 22% ROE or you can pay 10X – there is no formula for it. I don’t know about hte Nifty ROE – is 22% a high number historically or has it been falling? Is the ROCE considerably lower and going down?
      Btw Are you free float weighting the E or CE part when you aggregate numbers?
      4) Broad brushes are simplistic by nature. But most investing is simplistic by nature. Unless you want to invest in a company the concept of investing in an index is about simplicity; you will want simple valuation metrics then, not complex ones. (complex ones are for individual companies…)