We take a look at equity valuations and find that they have moved into even more expensive territory.
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.
On 13th October 2017, the Nifty PE Ratio was at 26.4 which is more than two standard deviations from the historical average and also much higher than the previous quarterly valuation of 25.2. Markets continue to move into more and more expensive territory from an earnings point of view and, if we use history as a guide, we may not see these returns continue in the short to medium term.
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 has moved down a bit to 3.5 from 3.7 in last quarter, but is still roughly around the long term average. On the basis of book value, markets are trading in the normal range. The difference between valuation indicators in the PE and PB could be due to the fact that capacity utilisation is very low. Therefore, even though the price is expensive on the basis of current earnings, it could be that an increase in utilisation levels could give a significant rerating to earnings in the future.
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. Towards the end of September, the dividend yield of the Nifty fell below the normal range, but it bounced back in October once the latest quarter numbers were taken into account. Currently, the dividend yield is at around 1.1, which is below the long term average of 1.5 but is still within 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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