Nifty P/B ratio edges above long-term average; analysts call sign worrying

Analysts say high P/B and drop in RoE a worrying sign

The price-to-book (P/B) ratio for the markets — a metric often cited by the bulls to justify the rally — is in expensive territory. Currently, the trailing P/B for the Nifty50 index is about 3.4x, compared to the historical average of 3.2x. 

The book value or net worth of a company is the difference between its assets and liabilities. It is the total assets of a company, excluding intangible assets (such as patents and goodwill) and debt.

Analysts say the P/B shooting above the mean is a worrying sign. 

“The P/B reaching its long-term average is proof that investors are not punishing the market for the economic fallout of the Covid-19 pandemic. The Reserve Bank of India itself is saying that the gross domestic product will shrink 9 per cent. The economic outlook is clear that we will take at least two years to reach the 2019-20 levels. But the market seems to be indifferent. The market has to correct at least 10 per cent for the P/B to price in the pandemic impact,” said G Chokkalingam, founder, Equinomics Research & Advisory.

Due to the erosion in earnings due to back-to-back lockdowns, the trailing price-to-earnings (P/E) for the Nifty has reached record levels this year. In the recent past, many analysts and fund managers have been advising investors to ignore the P/E as it got distorted and instead look at P/B, which continues to be reasonable. The current Nifty P/B is much lower than the 6x seen during the peak of 2007-08 bull market. However, above-average P/B, coupled with a drop in return on equity (RoE), could be a cause for concern. Also, India’s P/B premium to other emerging markets is currently above the mean.

“The RoE for India used to be slightly higher than in other markets. Since profitability was higher for Indian companies, so was the P/B. Now RoEs have got compressed,” said Abhimanyu Sofat, head of research, IIFL Securities.

Sofat said the P/B ratio for the Nifty is propelled by rising weighting of companies in the financial and services sectors. He said while the weighting of the financial stocks on the Nifty has come down, that of Reliance Industries has gone up due to its services business.

In March, the Nifty P/B had slipped below 2.2 — the lowest level in nearly 11 years. Since then, the index has rallied more than 50 per cent, while P/B has jumped 55 per cent. 

“This means prices have moved up, but earnings have not. The first quarter numbers were bad. We were already staring at a slowdown at the start of the year. This situation has been exacerbated by the onslaught of Covid-19. A lot of companies have reported losses. However, the markets bounced back as the risk appetite has gone up, despite the economic slowdown because of over-optimism about the economic recovery and a continued monetary easing. The P/B is likely to remain the same, even if companies post better numbers since prices are unlikely to come down,” said Siddhartha Khemka, head of research (retail), Motilal Oswal Financial Services.