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Where’s E in P/E Ratio For Investors Heading To?

Author: Dasari Sreenivasa Rao/Wednesday, September 23, 2020/Categories: Exclusive

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Where’s E in P/E Ratio For Investors Heading To?

D-St develops cold feet; Is It Wise For Investors to Rely on Liquidity-driven rally or going global; Can High P/E ratios justify yields; Can we expect similar yields next year too; Over 160 cos at 52-wk high; Rupee at 5-mth high as portfolio inflows lift stock markets

After reclaiming 11,600, NSE Nifty nosedived on Monday (September 21, 2020) and further to 11,153 level on Tuesday. BSE Sensex too touched 39,000, but couldn’t hold and slipped to 37,734 level. The Indian market bellwether, BSE Sensex was trading 10 per cent lower from the year’s high of 41,966.86 recorded on January 28, but still higher by 45 per cent from the year’s low of 25,981.24 points on March 23. From the year’s low of 25,981.24 mark, key indices continued to rise during the several phases of Lockdown and Unlock to 39,467.31 on August 28. After hitting 39,000 level, the market entered consolidation mode and became volatile with negative bias. Was the upward movement fundamentally strong? Market analysts attribute the reasons to portfolio investments and liquidity factors that propelled the key indices. Moreover, low valuations, bargain hunt and liquidity were the prime reasons for the market rally from March-end lows. Whereas, the current situation is totally different as liquidity has lost steam, valuations are high, while yields look uncertain. 

At this juncture, what key factors such as Price-to-earnings (P/E) ratio, price-to-book (P/B) ratio and dividend yields hold for investors?

Going by the track record, a passive long-term investor buys stocks when P/E reaches 15-16 and stops buying when P/E goes above 22. Analysts advise investors to buy Nifty BeES ETF. Nifty BeES is like a mutual fund, which tracks the NSE Nifty Index.

Let’s take a look at how P/E is moving this year so far. From the lowest point of 17.15 on March 23, 2020, the Nifty P/E ratio rose to year's highest of 33.26 on September 16 and slipped to 31.97 on September 22. The highest PE ratio doesn’t indicate that select scrip is overvalued as it also reflects willingness of investors to pay higher share price over higher growth expectations. But the yields hold the value.

“High valuations coupled with uncertainty and doubts over earnings will impact the markets in negative way in the days to come as the future yields may not justify such valuations. The markets may trade uncertain and investors are advised to stay cautious,” said a senior market analyst.

On FY22 estimates, Nifty's current P/E works out to be around 17, which is 21 per cent higher than the long-term average of 14 for the two-year forward P/E. Based on the two-year forward earnings, Indian equities are the most expensive after the US and Japan. 

As per the technical charts as on September 21, 2020, Nifty PE was 32.25, P/B Ratio was 3.13 and Dividend Yield was 1.45. Generally, Nifty is considered to be in oversold range when its P/B ratio is below 2.5 and it’s considered to be in overbought range when Nifty P/B is near 4. Dividend yield generally bounces in the range of 1-1.5. A dividend yield above 1.5 means it’s a good time to buy. The present yield is reflecting the performance of FY20. However, with sluggish demand impacting the topline of the industry, it’s difficult to maintain yields for the current fiscal i.e. FY21. Hence, investors are advised to stay long and should buy ETFs like Nifty BeES. Investors may also consider individual stocks when P/B ratio is near 2.5 to get maximum return from stock market.

With year-to-date (YTD) returns in the domestic stock markets indicating that Nifty is trading 982.55 points or eight per cent lower. Investors are puzzled over timing of the investment whether is it right time to buy, hold or offload? Analysts are skeptical about future earnings of the India Inc as majority of them forecast real recovery from May 2021 onwards, while some hold positive view in January-March 2021 quarter. Considering both the views, last quarter of 2020 i.e. October-December is going to be sluggish period for the investors. Further three more important factors will set the tone for the Wall Street, which in turn influence the global markets including India.

As per the reports from International Consortium of Investigative Journalism (ICIJ), top banks involved in money laundering to the tune of $2 trillion for more than 10 years. It impacted EU banks as well. The US authority already red-flagged it as suspicious. The transactions numbering over 18,000 during 2000-2017 are creating tremors across the US and EU. 

Secondly, political war between Donald Trump and Biden for the forthcoming presidential elections will have major impact on the markets. Thirdly, resurgence of coronavirus in the UK and Europe has already started showing signs of turmoil across the global markets.

What’s P/E Ratio?

By dividing the market price by the earnings per share (EPS), we get P/E ratio. Based on EPS of Rs67.33 as on March 2020, RIL’s PE ratio was 34.52. It means that investors are willing to pay Rs 34.52 for every rupee of earnings. The price-to-book ratio (P/B ratio) is another financial ratio that helps investors to compare a company’s current market price to its book value (BV).

Nifty PE Ratio Vs Nifty

Nifty PE ratio is a vital tool to measure valuation of all the companies included in Nifty index. If investors want to stay long, then low Nifty P/E ratio can be considered for identifying cheap stocks. High Nifty PE multiple is expensive and it warrants caution. Investors can consider high P/E ratio for booking profits or going short. When we look at the Nifty PE vs. Nifty charts, when Nifty PE ratio is at high (hovering at 25-30), Nifty will also be higher level of the chart and vice versa. Hence, the stock market suffers a sharp sell off when Nifty PE is near 25 and gets heavy buying support when Nifty PE ratio is round 12 to 15.

Value Investing

However, investors are advised not to depend on key indices - Nifty index or BSE Sensex – by their value momentum. The strikes of Nifty and Sensex are merely numbers and investors should take EPS of all the constituent stocks into consideration before taking any decision. Then only it’s considered as value investing. One can know whether the Nifty or Sensex is overvalued on the basis of its PE ratio rather than the value.

Yields may not support

For the first quarter, analysts estimate earnings for S&P-500 would be 12.3 per cent below their year-earlier level, according to I/B/E/S data from Refinitiv. Analysts in January predicted over six per cent returns for the first quarter of FY21. But the Covid-19 disrupted all the expectations as it impacted every section of the society. The September so far witnessed selloffs across the board. Bulls still consider the present market condition thinking that it’s too early to call it a stock market turmoil as several stocks — growth and value stocks alike — are trading at pricey valuations.

Relying on dividend yields on a trailing basis will be as misleading factor as many companies that will cut dividends in next few quarters. Even the PBV metric may be useful only in some asset-heavy cyclicals and some financial stocks. For many sectors such as IT, pharma, FMCG, it may not be of much use.

At the moment, the trailing P/E ratio of the global equity market is above 20. Dow Jones’ PE ratio as on September 22 was at 26.79 as against 19.25 a year ago. The current multiple is lower than the 30-year average price-to-earnings ratio which might indicate that the global equities could be are underpriced. PE multiples of several stocks have contracted. However, lower valuation may be an illusion as earnings may be hit in coming months.

P/B ratio-Dividend Yield

As on September 22 (Tuesday), Nifty P/B Ratio was at 3.10 and dividend yield was at 1.47. According to technical analysis, if P/B ratio is below 2.5, then Nifty is in oversold range. Nifty is considered to be in overbought range if P/B is at 4. Coming to the dividend yield, if it’s above 1.5, then it’s a good time to buy.  Analysts advise investors, who want to stay long, to go for Nifty BeES as well as fundamentally strong individual stocks when P/B ratio is near 2.5 to get maximum return from stock market.

Mkt crash during Covid outbreak

When coronavirus-induced lockdown hit the world in March, the stock markets were crashed in last week of March and first week of April. Half of Nifty-50 stocks were trading at single-digit P/E ratio. The key indices – Nifty and Sensex – tumbled over 33 per cent from its record high. It pulled P/E ratio of Nifty to 12.3 from 18 in January. However, analysts considered the Nifty valuation slightly above the 2008-09 global financial crisis trough level, when it had fallen to 11.

Almost over 50 per cent of the Nifty stocks are currently trading at a single-digit P/E ratio. So, it’s a good time for bargain hunting? Analysts caution investors on this assumption, while elaborating that such low valuations are a signal that the market is pricing in huge disappointment in earnings due to the demand shock created by the lockdowns to contain Covid-19. After Unlock began in June, the industry and business segments have not yet recovered 50 per cent so far.

What September holds for investors?

The US election season will influence the global markets as already the ongoing uncertainty about the polls is reflected in the stock market. Historically, the S&P 500 fell over two percent in the three months leading up to the presidential election. The market fall ahead of 2008 elections included the 20 percent drop due to the credit crisis. However, past performance wouldn’t guarantee future results. Anyhow, investors are advised to get prepared for short-term volatility.

Sluggish demand continues

According to a latest report from CII, the CII Business Confidence Index rose to 50.3 in the July-September quarter from 41 in April-June quarter. As the Centre has been lifting the restrictions on economic activities across the country, business sentiments are on recovered path. Despite the business sentiments strengthened, the demand in India continues to remain weak, as per the survey. The CII survey reported that more than half of the respondents (51 per cent) have indicated that the weakness in domestic demand may be the top-most risk to business confidence in the next six months. Further, nearly 30 per cent of the respondents feel that the business activity may return to the pre-pandemic levels by Q1 FY22.

Chandrajit Banerjee, director general, CII, said: “It is heartening to note the recovery in CII’s Business Confidence Index for the July-September quarter, indicating an improvement in business conditions during the period. However, while a recovery is underway, it could be tremendously expedited through continued government support and hand-holding of businesses during this crisis.” The ‘Current Situation Index,’ on the other hand, was recorded below the psychological level of 50-at 40.6- as the stringent lockdown restrictions led to the complete shutdown of most business operations for a larger part of the quarter, thus impacting business sentiments.

“The stellar recovery in the index has been supported by the remarkable increase in the Expectations Index (EI), which rose 46 per cent quarter-on-quarter, to the level of 55.2, as the nationwide lockdown restrictions were lifted, and businesses gradually began to reopen during the July-September quarter,” a CII statement said. The industry body CII carried out the survey during August-September 2020. Over 150 firms across all industry sectors including MSMEs and large enterprises, from different states took part in the survey.

Sebi allows FPIs to write-off shares

The Securities and Exchange Board of India (Sebi) has permitted foreign portfolio investors (FPI) to write-off shares of all companies which they are unable to sell. Under the existing norms, write-off securities held by FPIs, who wish to surrender their registration, has been permitted only in respect of shares of companies which are unlisted or illiquid or suspended or delisted. “However, in view of the requests received from various stakeholders, it has been decided to permit said FPIs to write-off shares of all companies which they are unable to sell,” it said. For the write off, the process prescribed in the SEBI's operational guidelines has to be complied with, the security market regulator said in a circular

The writer is a business journalist with 27 years of experience


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