We are up over 1000 points in the Nifty in little bit more than a month. And with any such move, the natural question comes up - is Nifty overvalued?
On a trailing 12 months basis, Nifty is today at 21.59 times earnings. Which is not low - but it isn't so high either. But if you consider a few metrics, then it becomes obvious Nifty is actually quite cheap.
- Banks have been beaten down significantly because of NPA issues. So much so, that today, the size of the NPA problem is only a fraction of the fall in market cap! Just imagine, if 1 year back, the banks all raised 10% equity via a Fund raising round, their market cap would stay the same, and their share prices would have fallen down 10%. And they could have used this money to make twice the provisions they have made so far! So this problem could effectively have been solved by just a 10% dilution in equity! Instead, this prolonged approach of using earnings to increase provisions has only dented earnings, and also reduced the multiple to earnings. SBI is trading at below 10 times this dented earnings! If it takes 2 years for SBI to provision for all its NPAs, at the end of that period, their earnings will shoot up - not because they will do anything different, but simply because they no longer need to provision! And if the NPAs actually start turning around - because of improvement in the economy, or lowering of interest rates, etc, or because of more stringent posturing by banks, then bank earnings will shoot up spectacularly. From a long term perspective, banks are valued very cheap, and to give an example - 2 months back, SBI was at 7.5 times earnings - at 155/share. Investing in SBI shares at that point would have been almost as safe and way more rewarding than investing in SBI Fixed Deposit!!
- Reliance is trading at 11 times earnings. Not very low, but quite low. But if you consider that in their left pocket, they hold India's largest and only profitable Retailer, and in their right pocket they hold what will soon be India's largest integrated Telecom and Media company. They have invested in the range of Rs 250,000 crores over the last 8 years in creating these two behemoths, as well as in significant investments in their petrochemical business. But despite that, their debt is just Rs 88,000 crore! Which seems high, but is just 3 years current earnings for just the refining business! Someday these businesses will be divested into separate companies. And Reliance will still be earning Rs 28,000 crores per year, and still be having the same market cap at 11 times earnings! But we will have two extra positions in our demat account, which will potentially be worth half much as Reliance! And this is not the case with just Reliance. ICICI, SBI and HDFC holds valuable stakes in insurance subsidiaries which doesnt get reflected in the share price.
- Forget undervalued stocks - investors rarely buy the Nifty - they buy individual stocks. If you remove just 3 stocks from the Nifty, the valuation multiple drops quite significantly. Just Sun Pharma, even after its big fall from peak levels, is trading at 50 times earnings!! You can imagine what Nifty multiple will be, if you exclude Sun Pharma!
- Investors are supposed to be forward looking. We are coming off a fairly prolonged recessionary period - where growth was quite sluggish. Interest rates were high, discouraging capex. Demand was also suppressed. Obviously, earnings growth was impacted quite significantly. If we are going to look at trailing earnings, valuations would seem expensive - but on a forward basis, it is quite possible that Nifty earnings could go up about 20% this fiscal. The estimates are for 15-17%, but I would bet that lower interest rates and more importantly, greater transmission of the lower rates will boost earnings quite significantly.
If you consider all these aspects, Nifty doesnt seem to be overvalued at all.
If you consider markets around the world - with much lower growth rate, SPX is having a higher multiple than the Nifty!
On a trailing 12 months basis, Nifty is today at 21.59 times earnings. Which is not low - but it isn't so high either. But if you consider a few metrics, then it becomes obvious Nifty is actually quite cheap.
- Banks have been beaten down significantly because of NPA issues. So much so, that today, the size of the NPA problem is only a fraction of the fall in market cap! Just imagine, if 1 year back, the banks all raised 10% equity via a Fund raising round, their market cap would stay the same, and their share prices would have fallen down 10%. And they could have used this money to make twice the provisions they have made so far! So this problem could effectively have been solved by just a 10% dilution in equity! Instead, this prolonged approach of using earnings to increase provisions has only dented earnings, and also reduced the multiple to earnings. SBI is trading at below 10 times this dented earnings! If it takes 2 years for SBI to provision for all its NPAs, at the end of that period, their earnings will shoot up - not because they will do anything different, but simply because they no longer need to provision! And if the NPAs actually start turning around - because of improvement in the economy, or lowering of interest rates, etc, or because of more stringent posturing by banks, then bank earnings will shoot up spectacularly. From a long term perspective, banks are valued very cheap, and to give an example - 2 months back, SBI was at 7.5 times earnings - at 155/share. Investing in SBI shares at that point would have been almost as safe and way more rewarding than investing in SBI Fixed Deposit!!
- Reliance is trading at 11 times earnings. Not very low, but quite low. But if you consider that in their left pocket, they hold India's largest and only profitable Retailer, and in their right pocket they hold what will soon be India's largest integrated Telecom and Media company. They have invested in the range of Rs 250,000 crores over the last 8 years in creating these two behemoths, as well as in significant investments in their petrochemical business. But despite that, their debt is just Rs 88,000 crore! Which seems high, but is just 3 years current earnings for just the refining business! Someday these businesses will be divested into separate companies. And Reliance will still be earning Rs 28,000 crores per year, and still be having the same market cap at 11 times earnings! But we will have two extra positions in our demat account, which will potentially be worth half much as Reliance! And this is not the case with just Reliance. ICICI, SBI and HDFC holds valuable stakes in insurance subsidiaries which doesnt get reflected in the share price.
- Forget undervalued stocks - investors rarely buy the Nifty - they buy individual stocks. If you remove just 3 stocks from the Nifty, the valuation multiple drops quite significantly. Just Sun Pharma, even after its big fall from peak levels, is trading at 50 times earnings!! You can imagine what Nifty multiple will be, if you exclude Sun Pharma!
- Investors are supposed to be forward looking. We are coming off a fairly prolonged recessionary period - where growth was quite sluggish. Interest rates were high, discouraging capex. Demand was also suppressed. Obviously, earnings growth was impacted quite significantly. If we are going to look at trailing earnings, valuations would seem expensive - but on a forward basis, it is quite possible that Nifty earnings could go up about 20% this fiscal. The estimates are for 15-17%, but I would bet that lower interest rates and more importantly, greater transmission of the lower rates will boost earnings quite significantly.
If you consider all these aspects, Nifty doesnt seem to be overvalued at all.
If you consider markets around the world - with much lower growth rate, SPX is having a higher multiple than the Nifty!
