As equity investors bid up share prices on Dalal Street, the valuation of the benchmark indices has hit an all-time high.
At the close of trade on Wednesday, the NSE Nifty 50 index price-to-earnings (PE) multiple reached an all-time high of 30.4 times its trailing 12-month earnings per share (EPS).
The current valuation is 38 per cent higher than the 10-year average of 22x and over 50 per cent higher than the 20-year average of around 20x.
In comparison, the index was valued at 28.6x at its life-time high of around 12,355 on January 16 this year.
The Nifty 50 valuation ratios are available from January 1999. (See the adjoining chart.)
Analysts attribute this to a combination of a steady decline in the Nifty 50 underlying EPS in the last two quarters due to the pandemic and a sharp rise in the index from the March 20 lows.
The index’s underlying EPS, which tracks the combined profit of the 50 Nifty companies, is down around 20 per cent from its highs but has corrected just 5 per cent during the period. The index’s current EPS is around Rs 365 against Rs 384 at the end of the March 20 earnings season and a record high of Rs 453 in January this year.
Analysts say, the index would have made a fresh lifetime high if not for the poor show by the stocks of banks and non-banking financial companies.
“After the sharp up-move during the four months, the Nifty excluding BFSI (banking, financial sector and insurance) has moved past its pre-Covid levels,” write analysts at Motilal Oswal Financial Services in their latest Bulls & Bears report.
The combined market capitalisation of BFSI stocks is down 28 per cent during the year so far.
The brokerage sees polarisation in the market as the rally is being led by a handful of stocks and there is a large gap between out-performers and the laggards.
“Polarisation remains the persistent theme – the top 15 stocks within the Nifty 50 are reflecting index levels of around 15k while the next 35 stocks are languishing near the 8,400 levels,” write the analysts at Motilal Oswal.
For example, Reliance Industries has seen the biggest rerating in valuation in the past four months and the stock is now trading at a trailing PE of 25.2x against the 10-year average ratio of 13.6x. Other index stocks trading at a large premium to their historical averages include HCL Technologies (80 per cent), Titan (68 per cent), Infosys (64 per cent), and Nestle (50 per cent).
In contrast, many industry leaders have seen a large erosion in their valuations in 2020 due to their poor growth and earnings outlook. NTPC, for example, is now trading at a 53 per cent discount to its 10-year average valuation, followed by Coal India (52 per cent), Bharti Infratel (49 per cent), ONGC (48 per cent), and GAIL (47 per cent).
Motilal Oswal has said the market is not looking attractive as it did in March this year when the index PE ratio hit a seven-year low of 17x on March 23.
Analysts say as the index valuation increases, the upside gets limited for investors. “The current valuations are not sustainable unless the Covid vaccine hits the market in the next few weeks and it can trigger strong earnings growth in FY22. Otherwise, it raises the risk of a sharp correction,” said G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.
He has attributed the rally and valuation re-rating of popular stocks to a surge in retail participation. “Unlike institutional investors, whose investment is research-driven, retail investors largely play on the market momentum, which accentuates valuation on either side,” he added.
Others, however, see a greater upside in the broader market, given the ample liquidity globally and lack of viable investment opportunities for global investors.
“In our base scenario the Nifty 50 is expected to hit 12,000 by the end of the current year and the index could touch even 13,500 if economic conditions turn out to be better than expected,” said Dhananjay Sinha, head (research), Systematix Institutional Equities.
According to Motilal Oswal, 10 of 15 key sectors are trading at a premium to their 10-year average PE multiples. The valuation premium is the highest in retail, followed by automobiles and oil and gas.
For example, retail stocks are trading at a PE of 120x against their 10-year average of 60.7x, while for automobile stocks it is 38.1x against 10-year average of 24x.
In contrast, valuation discount is the highest in public sector banks, followed by power utilities and media companies. Public sector banks are trading at a PE of 12x against their 10-year average ratio of 30x, while power utilities such as NTPC, CESC, Power Grid, and Tata Power are trading at 7.1x their trailing earnings against their 10-year average ratio of 12.6x.