In last few months, we have seen continues flow of domestic money into equity markets. The monthly systematic investment flow into mutual funds has now grown to almost 4500 crore (MFs get record monthly SIP inflows). This has made Indian stock market far more resilient and less vulnerable to foreign institutional flows. However, increasingly there are concerns around valuation of the equity market. Using trailing P/E ratio (price to earning), P/B ratio (price to book value) and dividend yield, we analyse the valuation of Indian equity market.
In the absence of earnings growth, the continuous rise of the equity market has also stretched the valuation. As a result, the valuation metrics have consistently become more and more expensive. NIFTY trailing P/E ratio (provided by NSE) is currently 25.1x, much above the long-term average of 19x (see the table below). The same is valid for P/B ratio (currently 3.7, much above long-term average of 2.1) as well as dividend yield (currently at 1.1, much below long-term average of 1.8).
Source: NSE, Keep Investing
Rich valuation has not been due to explosive rise in equities. Despite market hitting all-time highs on a daily basis, rolling 5-year return on NIFTY is marginally below long-term average. Significant return in equity comes from a combination of P/E re-rating in an environment of higher earnings growth (for example 2003 to 2007). Over the last 5-years NIFTY earnings have grown at very low pace. This means that while NIFTY P/E ratio is high, this is also due to cyclically weak earnings growth. Deep market correction happens when earnings growth and valuation peak simultaneously (as happened in 2007-08). So, we could see a market correction or time correction going forward but chances of deep market correction is less as earnings growth is unlikely to fall further and should actually recover.
How expensive is the Indian equity market? The current P/E ratio of NIFTY (25.1) is quite high in historical context. In past, NIFTY has spent less than 5% of the time above current P/E ratio (since 1999).
From the above discussion, it is clear that:
- Indian equity market is in expensive zone.
- At such expensive valuation, caution is indeed needed.
- We always think that valuation should be used as a guide for investments. You can read more about this in Using valuation as a guide for asset allocation.
The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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