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Nifty PE – Market Valuations – April 2020

At the current PE of 19.52, Nifty is at its cheapest since 2014. The long term mean PE of Nifty is 19.95 and we are just a tad bit below those levels.

Market Valuations through PE Chart

Nifty PE Chart

Over the last 4 years, the markets have traded at premium valuations. Trading at such valuations, in the hope of higher earnings growth, for such a long time made the investors think that 22+ PE was the new norm. Fund managers justified it citing forward Nifty PE ratios. We have been through a period of subdued earnings growth due to multiple factors and the growth has always been on the horizon, but it never came.  Nifty’s earnings are growing at ~ 9% and they have been below 10% for the last 4 years. Once again it has been proven that investing at higher PEs can give negative to low returns for few years.

Looking at other ratios

On the price-to-book ratio, the market is well below its long-term average. While the mean PB Ratio is 3.5, the market is trading at a PB Ratio of just 2.47 now. Although, the return on equity of the Nifty is at ~ 12.65%, well below the cost of capital in India that is 14%. A lower ROE results in a lower price to book ratio paid by the market.

Market Valuations are cheap when we look at the PB Ratio

Market Valuations are cheap when we look at the PB Ratio

While the low EPS growth rate has depressed the earnings part of the PE ratio, making it seem still above the long-term mean, there are indicators which show that the market is cheap and ripe for long term investments.

Indicator Current Mean Valuation
PE Ratio 19.52 19.95 Fair
PB Ratio 2.47 3.54 Cheap
Dividend Yield 1.76 1.42 Cheap
M.Cap to GDP 58% 78% Cheap

 

The market cap to GDP ratio is at 58% today and in the past from such levels the markets have delivered a CAGR of ~ 15% over 3 years. However, how much will the markets deliver over the next 3-5 years really depends on earnings growth. Forecasting the next year’s NIFTY EPS is like shooting an arrow in the dark. But we can develop an expectation of earnings growth over the next 5 years.

How fast will earnings grow?

The corporate profit to GDP ratio is at ~ 3.5% which is below the mean of 4.2%. At the time of the 2008 meltdown, the ratio was at ~ 7.1%. On this parameter too, we are not trading at expensive valuations and eventually this ratio will revert back to its mean.

Market Valuations are cheap on a CP to GDP basis

Corporate Profits to GDP

Assuming an average GDP growth rate of 6.5% and inflation of 5%, we get a nominal GDP growth of 11.5%. With a corporate profit to GDP ratio of ~ 4%, we get an earnings growth of 15% to 16%.

Impact of Covid-19

It is impossible to predict when the world will be back on its feet. Will a 21 day lockdown be sufficient or will it be extended? Will there be normal business after the lockdown or will there be a long travel ban and partial resumption of business? The world will never be the same again, and the Indian markets will be affected too. The Government will have to let go of its fiscal discipline and provide a stimulus package to rescue the economy. In the financial crisis of 2008, the Government had provided a package that was 3.5% of the GDP and we reckon that this time it could be well above that figure.

Is this a good time to invest?

If the situation gets grim, Nifty might also touch PE levels of < 15. In 2003 and 2008, the Nifty traded at PE levels of < 12. However, it is a good time to invest for the next 5 years. While you may not see positive returns for the next 12-18 months but a historical analysis of PE levels shows that it indeed is a good time to invest.

Good time to invest

Returns from different PE levels

If you have invested in 2017, you probably are in negative returns or at the best, low single digit returns now. However, don’t lose hope. Investing in equities for the long term WILL be a test of patience and conviction. Investing at PE levels of 22+ can require 5 years to see any decent returns.


Be fearful when others are greedy and be greedy when others are fearful – Warren Buffet


We advise investors to increase their investments if possible. If you have cash in your portfolio, you can consider systematically deploying it in equities. You must review your equity portfolio diligently because stocks that performed well in the previous bull run may not necessarily be the leaders of the new bull market.

If you are making SIPs, then continue your SIPs. However, it is advisable to review your mutual funds portfolio for the funds. We advise against having thematic funds in your portfolio if you are a passive investor.

Market Valuations – November 2018

Market Valuations

Over the last few weeks, the Nifty index has seen a decent double digit percentage correction. The midcap and smallcap index are performing even worse. The buzz on the street is that the market valuations are at a healthy zone and it is a good time to start picking stocks. The current valuations of the Nifty 50 index are given below.

Market Valuations

The mean PE of the Nifty is ~ 19 and the index is now trading above it’s +1 Standard Deviation. The PE Ratio was at 28.55 in late August 2018. When the PE Ratio is high, the prospective returns are low even over a multi-year period. Sticking to quality stocks at low to fair valuations and a healthy percentage of cash in the portfolio can help navigate inflated valuation periods in the market.

PE Ratio Chart

The current valuations of ~ 25x PE is still not cheap especially when the earnings growth is just 8% p.a. The market is bullish and stock prices rally as PE multiple expands. However, the returns earned over 12-18 months can vanish overnight as investors have seen multiple times in 2018.

The Return on Equity is a dismal 13.17% particularly due to lower margins. For ROE to improve, earnings will have to grow. Earnings growth will come with revenue growth and expansion of profit margins.

Historical ROE Chart

There are signs of recovery in revenue growth based on Q2FY19 numbers and also the RBI data on Capacity Utilization. An increase in the CU is a strong indication of demand picking up. The order book growth of large infrastructure and heavy industry companies also points towards a healthy growth in revenues and earnings over the next few quarters. Even if revenues grow by 10%, the margins will have to expand for earnings growth to be > 15%.

RBI Data on CU

 

Outlook

We believe that the Nifty index will return a CAGR of 8% to 10% over the next 5 years. A good portfolio of equities will still able to deliver returns of 20% p.a. and higher over the same period. Our portfolio for new investors is still cash heavy with nearly 60% of the funds deployed in cash (Check out our Live Portfolio). Most of the mid and small caps still trade at premium valuations to what they ideally should be commanding. For example, many auto ancillary companies with low pricing power still trade above 20x PE.

While the market valuations cool off in a rising interest rate environment, we continue to add good quality stocks at fair valuations to our portfolio.

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Sentiments – Market Correction and More

The market correction is real. For a layman who doesn’t track the stock market, nothing has changed. The Nifty and Sensex are down just 5% to 7% which is normal for a volatile asset class like equities. But most of the portfolios in the market (Funds, PMS, retail accounts, etc) are down in double digit percentage.

Market Correction

Market Correction Impact

As evident from the table above, the smaller companies are bleeding. Most of the retail portfolios are heavily invested in small & mid caps. Most of the stocks below Rs 10,000 Crores market cap are down by more than 30%.

How many are down?

More than 81% stocks are down by 20% or more. Infact, more than 50% stocks are down by 40% or more. This gives a true image of the market breadth. While the broader indices look fine, the stocks have already undergone a deep correction in value. Moreover, we believe that many stocks will never see their previous highs.

Value Picks

In the sub – 1,500 Crore market cap space, there are many companies across different sectors. Investors should understand that not all sub – 1000 Crore companies can become Rs 10,000+ Crores organizations. Just because a company has fallen 50% doesn’t mean that it cannot fall another 50%. Investors should be careful in selecting the company to invest in. Just because a company’s stock price went up 500% the last time, it doesn’t mean that it will go up 500% the next time too!

Some factors that we would be looking for – Ethical management, improving margins, sustainable earnings growth and the return on capital. Do drop in your comments about the market!

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