But as an investor it now becomes extremely important for you to do a reality check on the fundamentals as to whether this unprecedented run of the market is being supported by the macro economic data or not, and how much strength does the market possess at these levels?
The price of a stock or an index is always a reflection of its earnings base. All of us are well aware of the fact that the pandemic has hit the earnings of businesses badly. Now when businesses are bouncing back into action, almost every company is showing an improvement in their quarterly results.
A look at the consolidated earnings of Nifty50 companies shows it was at almost Rs 358 per share average in August 2020, and has been continuously improving since then. The same figure averaged at Rs 446 in April, 2021 and Rs 607 in August 2021. Therefore, if you look at the PE data of this year, it is continuously on a decline, even though the key indices are touching new levels.
Let’s take a look at the data to check what all it reveals:
Now, a big question emerges here: Is it worth buying Nifty50 at 26.25 P/E? To answer this, we have to look into some of the key facts:-
1) Historical P/E: FY 2020-21 was an exception, therefore we cannot take the data of this year into consideration while calculating the average. However, if we look at the historical data of the past 5 years before FY’21, Nifty50’s P/E average stood at 24.78 from the beginning of FY 2015-16 till the end of FY 2019-20.
Therefore, at 26.25 level it is almost 6% higher than last five years’ average.
2) Nifty50 P/E calculation: As we know, NSE has changed the calculation method for Nifty50 P/E. Now it is calculated on the basis of consolidated earnings of all the companies instead of standalone P/E. This calculation has changed the P/E data significantly. It is important to note here that after this calculation change came into effect, Nifty50 P/E immediately came down to 33.2 from 40.43 on March 31, 2021.
3) Future growth: If we evaluate the P/E of any company or any of the indices, we must look at the future earnings expectations as well. Current higher P/E may be the result of market expectations of higher earnings in the future.
Conclusion: P/E is the most important factor for market strength analysis and it is running higher than its five-year average. It may be the result of the market expectation of higher earnings growth for the Nifty50 companies, which is very much likely as the festive season should pan out well and the good monsoon would also do its bit to improve rural income and thereby demand in the economy. So, long-term investors who have a 3-5 years kind of investment horizon should not fear a Nifty level of 16,500 or a Sensex level of 55,000, and should try and ride the rally with fundamentally strong and cash flow positive stocks.
(Ravi Singhal is Vice-Chairman of GCL Securities. Views are his own)
