Indian share markets have rallied sharply of late, hitting fresh record highs and drawing the attention of investors from all over the world. However, as the benchmark NSE Nifty 50 has soared amid the volatility, its P/E ratio has jumped too. The current P/E ratio is 22.5. Is this expensive? Analysts have mixed views on the valuation, but mostly agree that it’s the future earnings that will guide the P/E ratio going forward.
Nifty’s current P/E ratio valuation: expensive or not?
“Fundamentally, if we consider FY23, Nifty is at an expensive valuation (22 times),” said Shrikant Chouhan, Head of Equity Research (Retail), Kotak Securities. “However, with FY24 earnings estimates, indices are at 20 multiples,” he added. Contrary to his opinion, Anmol Das, Head of Research, Teji Mandi, said that the current ratio is much lower than pre-pandemic levels. During 2018 to 2020, corporate earnings had stagnated while the index continued to rise, leading to the expensive valuation of +25.0x.
Earnings growth potential allays overvaluation fears
Indian markets are trading above-average valuation, but as earnings will continue to grow in the next few quarters, valuations will adjust by 100-200 bps in the near term, said Sahil Kapoor, Head of Products & Market Strategist at DSP Mutual Fund. According to Kapoor, unless there is an unknown trigger, sharp correction is unlikely; however, valuation adjustment will happen gradually over the next couple of quarters. (Read full story: Sahil Kapoor Interview) Anmol Das of Teji Mandi echoed the view. “(I) Don’t believe Nifty is overvalued at these levels, as corporate earnings growth is catching up quickly and set to grow further in H2FY23.”
“Nifty 50 is currently trading higher than its long-term historical average of around 16x. Thus if one looks at it from a long-term historical perspective, Nifty 50 is currently overvalued, but one needs to be cognizant of the fact that India remains an island of stability amongst major economies globally, which are expected to witness a significant slowdown in growth,” said Nishit Master, Portfolio Manager, Axis Securities PMS.
What is an ideal P/E ratio for Nifty, if there is one at all?
“18 P/E is reasonable, and as we are discounting to the one year forward, if we see 10% correction, it would be ideal for the market,” said Shrikant Chouhan of Kotak Securities. Although, as the breadth of the market evolves, the ideal P/E ratio changes too. “Nifty P/E valuations are considered rich at levels above 25x, if we are considering last five years data. However, going back over a decade, a P/E ratio above 21x is also rich,” said Anmol Das, Teji Mandi. For new entrants to the market, entering at a lower P/E ratio is always suggested. “But, getting to those levels seems difficult in the current scenario,” said Nishit Master, Axis Securities.
Will there be a correction in Indian equities markets?
“Most factors triggering a correction in the markets are global, including higher than-projected rate increases by the US Fed or ECB or failure of the major global financial institution due to increased volatility in some asset classes. Another risk is a default by a major developing economy or a geopolitical crisis across Taiwan Straits. On the domestic front, an extremely populist budget can lead to a market correction, but we ascribe a low probability to this,” said Nishit Master, Axis Securities.
However, specific to Nifty, “Q3FY23 earnings numbers will be a major factor for the PE to be more expensive,” stated Shrikant Chouhan, Kotak Securities. One thing that most analysts agree with is that there will not be a heavy correction in the future. “Instead, we are expecting a new rally in the next 3-6 months as increasing corporate earnings will require the Nifty 50 index to catch up with it,” said Anmol Das, Teji Mandi.
So how should you invest in Indian shares now?
“Nifty is trading at PE of 19.8x on FY24E and 17.1x on FY25E earnings, and Nifty earnings are expected to grow by 16.3% in FY24E and 15.5% in FY25E. One can look at mid-cap companies having strong management pedigree, business moat, strong cash flow, but due to short term headwinds valuations have improved”, said Sumit Pokharna, Vice President – Fundamental Research, Kotak Securities. “At this juncture, investors should focus on a stock specific approach rather than just focusing on Nifty. Focus on quality companies in various sectors which have strong growth potential and valuations are reasonable. Just to highlight, IT valuations have become more palatable,” he added.