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Sunday, November 21, 2010

Nifty Fundamentals Revisited

The Market isn't Galloping Away, Why ? 

Indian stock market seems to be in the threshold of a correction after going through a strong rally. This rally   raised the stock prices to very expensive levels on the back of  the relentless FII buying helped by the cheap overseas money and a rising Rupee. On a point to point basis, both the major stock indices, Nifty and BSE Sensex have not been able to surpass their intraday highs of January, 2008 in the recent rally. This post attempts  to take a look at the reasons for the non-performance of the stock market  in the entire past three years from the point of view of the trailing fundamental valuations. 

Indian Stock Indices - All Time Highs


The above table shows the all time highs of Nifty futures, Nifty Index and BSE Sensex during the period. The table shows that new closing highs were achieved during the recent rally. Now, let's make a comparison of the trailing fundamental valuations of the S&P CNX Nifty Index at these market tops.

Nifty Index - Trailing Valuation Comparison 

   
The above table shows the trailing Price to Earnings Ratio ( PE ), Price to Book Value Ratio ( PB ) and the Dividend Yield Ratio ( DY ) of the Nifty index as on 9th January 2008 and 9th November 2010.  Both these dates were selected from a sample on the basis of  comparable dates on which any of the indices or futures reached their highs in the selected period. As the trailing valuation levels are updated on the basis of quarterly results, the valuations of January 2008 are related to the quarter ended September 2007. Similarly the valuation data of 9th November is mostly based on the September 2010 quarter. Hence the study covers a full three period starting from Sept. 2007 to Sept 2010.  

The trailing valuation levels  of Jan. 2008 are very near to the all time high valuations ever achieved by the Indian stock markets between 1999 and 2010. ( For more information and analysis of the historic Nifty trailing valuations,  please click here to read  the Nifty Fundas page on this blog. )

In the context of the above facts, let's compare the PE Ratios of both the data points. Before that let's  make a simple assumption that the Nifty Index values were one and the same on these selected days. Everybody knows that the PER is calculated by dividing the Price ( Index Value ) by the Earnings Per Share ( Index Earnings ). Since the nominator of the equation ( ie. Index value ) is assumed to be the same, the difference in the PE multiple can be explained only by the quantum of profit growth achieved by the index constituents during the study period. Now, let's jump a step further to find the growth of profit achieved by the whole Nifty fifty companies during the three year period  by  calculating the decrease in the PE multiples between the data points. We see that the actual decrease in the PE Ratio is just a meager 10.5 %  in the three year period.  Therefore, the actual profit growth achieved by the Nifty companies is also the same 10.5%.  And if we convert the total growth of 10.5 % in a three year period to an annual growth rate by dividing the total by three ( ignoring the compounding effect ),  we get an even meager 3.5 % p.a. growth.   A study by the Businessline news paper also says that the corporate profits increased only by a meager 3 % in a two year period between March 2008 and March 2010.      

The PEG Ratio, which is calculated by dividing the PE Ratio ( PE Multiple ) by Growth ( Growth Rate ), gives  some semblance of  common sense in the valuation of growth companies. This tool can be utilised in the index valuation too. Any PEG valuation above one ( 1 ) is normally considered as a symptom of  overvaluation. Accordingly, the minimum expected growth rate should at least be equal to or higher than the  current trailing PE ratio to justify an investment in an index or share. As such the latest Nifty trailing PE multiple of 23.47 times as on 19 November 2010 can only be reasonable if the Nifty companies achieve a minimum of 23.5 % growth in profits one year forward. Another Busisnessline study says that the the year on year ( YOY ) profit growth achieved by some 250 companies for the quarters June and September 2010 were just 14 and 16.4 % respectively. Therefore, the Nifty companies need to raise their profit growth to much higher levels to justify the existing PE multiple which otherwise is still on the very expensive levels. 

However, there are some silver linings too in the horizon. The fall seen in the Price to Book Value Ratio ( PB Ratio ) during the period offers some hopes. This ratio has fallen by a significant quantum of 40 %  during the period. This may indirectly indicate the quantum of  new investments made by the Nifty companies in the three year period. Earnings from these now unproductive assets may be the stepping stone for the next growth cycle, provided the international markets do not spook the India growth story. Irrespective of whichever scenario of growth plays out in the future, the fact remains that the Nifty companies are yet to provide the profit growth they were expected to deliver to justify the high valuations of Jan. 2008 and even  the present valuation levels are expensive.
Now, the reader might be inclined to point out to this author that the market indices are still way below the Jan. 2008 high levels and this fact alone proves that the valuation levels then were high. And this author's answer to such a question would be : 'Yeah, that's true and that's all I wanted to convey with a request to carry this common sense approach to your future investments too !'

Cheers and Prosperous Investing  !!!

Keywords : Fundamental Analysis, PE Ratio, PB Ratio, PEG Ratio, Trailing Index Valuation, S&P CNX Nifty, Profit Growth.
     
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