NIFTY View

Nifty Valuations - Q1 FY15-16

The 1st Quarter of FY 15-16 has ended and companies will soon be coming out with their numbers. Let's look at the valuation of Nifty based on it's EPS, P/E, P/B and DY.

Let's first look at the P/B (Price to Book) ratio and DY (Dividend Yield)

PB Ratio:

The average PB Ratio of the index is 3.56 when taken for the period of 1st January, 1999 to 2nd July, 2015. The current PB Ratio of Nifty is 3.51 which is a tiny bit lower than it's average. Usually the market is considered ripe for investments when P/B ratio is 3 or below and overvalued when P/B ratio is 4 or above. From the past 1 year the market has sustained above the 3.5 mark and the market has not seen any major crash from these levels of PB Ratio. From mid 2009 to end of 2010, the market traded in a PB ratio range of 3.5 and 4 and after that corrected to the levels of 2.8-3 in the beginning of 2011. So as per historic PB ratio valutaions, we can say that the market is fairly valued and this indicator doesn't indicate a crash but doesn't leave much room for an upmove too!

P/B Ratio Chart - Click to expand

Dividend Yield:

The average yield of the index is around 1.46% and the current yield is 1.42% which is a little above average. When the yield is above 1.7% it is usually considered good for investment and below 1.3% it is considered expensive. Before the 2008 crash the yield had fallen to below 1% mark and after the crash it was close to 2.2% levels. So as per DY, the market is fairly valued and doesn't give much room for an upside.

DY Chart - Click to expand

Now let's take a look at two important parameters of valuation: EPS (Earnings per share) and P/E (Price to earnings) ratio.


Earnings per Share:


EPS Chart - Click to expand
For the first time after the 2008 crash, the market has seen a big fall in the EPS of the Nifty index. Similar to that phase, the EPS has fallen close to 10%. A fall in EPS is a danger sign in a bull market as it shows divergence between the market's expectations and ground reality. The earnings of companies are just not picking up! But the market is rising. Infact, on a QoQ basis the EPS of the index has fallen from 368.6 on 1st July 2014 to 360.7 on 1st July, 2015. In this period the market has rallied from 7650 levels to 8500 levels. In the next couple of quarters if the earnings don't pick up then expect serious trouble for the market. In a scenario where consider the growth in EPS doesn't pick up and the market creates new highs of 9200+ levels then we can expect a big crash coming. Let's see how the EPS moves after the Q1 numbers of companies. TCS has warned of a fall in earnings growth due to Visa costs and other factors which will severely impact all IT company earnings. Falling EPS indicates no scope for a rally and is a WARNING symbol for investors.

Price to earnings ratio:

P/E Chart - Click to expand

P/E is probably the most discussed, dynamic and disputed ratio. Long story short, it is a gauge of investor expectations. The average P/E of Nifty is 18.56 and currently it is trading at 23.4! 23.4 is a high P/E and shows that the investors are expecting high EPS growth, maybe more than 16%-17% while the market is giving negative growth. As per P/E, the market is too expensive for investing now. Usually a P/E above 24 is considered over valued. On 4th March, 2015 the market made it's all time high of 9100 levels and the P/E at those levels was 23.86. Now, the market is near 8450 and the P/E is 23.56 already! If we are to break the previous high in a falling EPS scenario the P/E will expand to 25.5-26+ which is a very expensive valuation. The market has crossed the 25 P/E thrice as shown in the chart. All the times, the market rallies very fast at such high valuations and crashes deeply later. The current levels don't look sustainable as per the P/E approach.

Now What?

Well you cannot just go out now and start shorting as the market can stay expensive longer than you can stay solvent. When trading at a P/E above 24.5, the market usually rallies fast and stays above this level for 2-3 months as per historical data. We aren't there yet. The Q1 earnings will not give the EPS the required boost as per our analysis and expectation. By the end of Q2, we could see the market head close to the 9000 mark near it's previous highs and then an eventual correction. Till then for the next 2-3 months expect consolidation and a 8200-9000 range Nifty. We have been talking of consolidation at these P/E levels in our previous valuation reports. This time, we say a rally till the previous high is very much possible. There is more chance of 9000 than 8000 at these levels and bullish sentiments. But watchout, there will be a storm approaching when we touch those levels.
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