The Nifty has fallen roughly 7 per cent since the 8th November demonetisation announcement. We take a look at the equity valuations and find that they are now trading in a more normal range compared to previously expensive valuations.
We use data from the NSE website starting from when it is available in January 1999 to look at the P/E Ratio, P/B ratio and the dividend yield of the index and compare it to past history.
In the chart above, the red areas highlight when the PE ratio is significantly higher than normal implying that markets are expensive and future returns are likely to be lower than in the past. On the other hand, green areas show when the PE ratio is significantly lower than normal implying that markets are cheap and returns from equities should be higher than average.
As on 24th November, the Nifty PE ratio was at 21.3, significantly lower than the 23.7 figure from our last quarterly valuation update. Markets have thus moved from expensive territory to a more normal range. It is important to remember however that this is based on trail earnings. Demonetisation will cause earnings to drop over the next few quarters and thus even though the PE seems optically cheap, the actual valuation may be far more expensive. It is difficult to predict this and we will just need to see the impact as it feeds through the economy over the next few quarters.
Similar to the PE chart above, red areas in the PB chart denote times when markets are expensive whereas green areas show when markets are cheap relative to history. The price to book ratio of the Nifty was at 3.0 which is below its long term average of 3.5. On the basis of book value, markets are trading in the normal range.
The dividend yield chart denotes value in a manner that is opposite to the PE and PB charts above. When the dividend yield is higher than normal, it means that markets are cheap. Similarly when the dividend yield is lower than normal, it is a sign that markets are expensive. In November, the dividend yield of the Nifty was roughly 1.4, which is below the long term average of 1.5, but it is much higher than the previous quarters number of 1.2. On the basis of dividend yield, markets are trading in the normal range.
Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.
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