Nifty valuation at multi-year highs on most counts

Following the sharp 6 per cent rally over the past month, the valuation of the benchmark Nifty 50 index looks filled to the brim on many counts. On parameters such as forward price-to-earnings (P/E), earnings growth expectations and cyclically adjusted P/E ratio (Cape), the markets are most expensive in 10 years. Meanwhile, valuations are the highest since 2010 when it comes to indicators such as market cap-to-GDP, bond–earnings yield spread and price-to-book value (P/B) valuations, according to an analysis by ICICI Securities. Current Cape for Nifty 50 is around 24 times, a range last seen during 2007-08. To compute Cape, earnings are adjusted to long-term inflation to smoothen out the impact of business cycles.

“Given that the cyclical recovery in earnings growth is at its nascent stage, valuations are surely ahead of fundamentals. Real earnings growth has been flat for the Nifty 50 in the past five years,” says Vinod Karki, vice-president, strategy, ICICI Securities, in a note. The brokerage’s proprietary valuation metric, market implied long-term growth value (MILTGV), which measures the value attributed by the market to growth in earnings beyond fiscal 2019-20, is at 54 per cent, a level last seen in 2008. The brokerage says the market is “attributing the substantial value” to long-term growth in earnings than to current and near-term future earnings. Meanwhile, except for 2018 highs, the one-year forward P/E at 18.3 times too is highest since 2008. Market cap-toGDP and P/B are the two metrics where valuations have not yet touched the 2008 levels.

Current, price-to-book ratio for the Nifty is 3.2 times, most since 2008. “Although P/B appears much lower than the 2008 high of nearly six times, it largely reflects the significant fall in return on equity (RoE) from 29 per cent in 2008 to 13 per cent currently,” says ICICI Securities. Currently, the market cap of all listed stocks is ~154 trillion, while the 2017-18 GDP stood at ~167 trillion, translating into the market cap-to-GDP ratio of 92 per cent. This is also the highest since 2010, when it had hit 95 per cent.

Further, the spread between 10year bond yield and earnings yield has widened to 221 basis points, reducing the attractiveness of equities. Narrower the spread, more lucrative it is to invest in equities. The yield on the benchmark 10year government bond, considered to be a risk-free rate, currently is at 7.76 per cent, while estimated oneyear forward earnings yield for the Nifty is 5.5 per cent. Given the sharp spike in the bond yield this year, the relative attractiveness between the two asset classes has tilted in favour of bonds, says another expert. ICICI Securities says given the valuations, there is little margin for error.

“We believe the current premium valuations have their underpinnings on superior earnings growth expectations and any disappointment on earnings front could lead to de-rating of valuations. We have a neutral rating on the Nifty 50 at these levels and maintain our March 2019 target of 11,500,” it said.