How expensive are the Indian stock markets? A quick check on PE multiples

Propelled by liquidity, the Indian stock markets have been mostly on an upward trend in the last few months with the frontline indices, the BSE Sensex and the Nifty 50 reclaiming the 82,000 and 25,000 levels, respectively.

The run up in the markets in the past few months has made valuations expensive, analysts said, who now expect the rally to take a breather for the next few months as corporate earnings catch up.

A quick look at the valuation metrics in terms of price-earnings (PE) of the frontline indexes on the National Stock Exchange (NSE) suggests that Nifty 50 index is trading at 24.7x, which is in line with its 5-year average, but a tad higher than the 10-year average of 23.4x, as per Bloomberg data.

 

By definition, PE ratio is a gauge of a company's stock price relative to its earnings per share (EPS). Typically, experts use this metric to analyse the current valuation of a company's stock with its five or a ten-year average. A high PE compared to the five/ten-year averages indicates that the stock is overvalued, or the markets expect a higher rate of growth going ahead.

Meanwhile, out of the 8 frontline sectors that includes banks, information technology (IT), metals, real estate, public sector enterprises (PSE) and auto, five sectors are currently trading at a higher PE multiple compared to their 10-year average, Bloomberg data shows. 

 

The Nifty Midcap 100 index at 47x PE, too, is far away from its five-year average of 36.4x and 10-year average of 32.4x, data shows.

Valuations, said Bhaskar Laxminarayan, chief investment officer for Asia and head of Asian investment management at Julius Baer, are a big overhang for foreign investors when he talks to them about investing in India.

“In fact, the biggest conversation we have with them is on valuations of (the) Indian markets. The next is politics. Every investor understands India's growth story, but valuation is a worry. Valuations of large-caps is not much of a worry as is the case in the small-and midcaps (SMIDs) and microcaps. We prefer the large-cap space in the Indian context. Within sectors, we like the consumption and infrastructure sectors,” Laxminarayan said.

In P/E terms, the Nifty 50, data shows, is trading at around 89 per cent premium to the MSCI EM index, above its historical average of around 50 per cent. Stable macros, broad-based earnings growth and robust banking/corporate sector health, analysts said, are driving this premium.

That said, geopolitics, US elections and crude price remain key risks, especially post the recent escalation in the conflict in West Asia. Any shift in government’s fiscal priorities post state elections, they believe, can also emerge as a medium-term risk.

Banks, fast moving consumer goods (FMCG), Larsen & Toubro (L&T) and Reliance Industries (RIL) are the sectors and stocks where G Chokkalingam, founder and head of research at Equinomics Research finds valuation comfort at the current levels.

“Over the next 12 months, it will be difficult to make 15 – 20 per cent return in the markets as the valuations appear stretched. That said, I would prefer to be in large-cap stocks as opposed to mid-and smallcaps purely from a risk-reward scenario. One needs to be selective,” he advises.