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 25th January 2019, the Nifty PE Ratio was at 26.1 which is more than one standard deviation from the historical average of approximately 19. Market valuations have corrected from the value of 28.1 seen in August, but continue to remain expensive territory from an earnings point of view.
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 stayed 3.3 and is just below the long term average of 3.5. 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 cyclically suppressed earnings. Part of this could be due to low capacity utilisation and part of this could be attributed to structural NPA issues with public sector banks that are depressing earnings. Therefore, even though the price is expensive on the basis of current earnings, it could be that an increase in utilisation levels or a normalisation of the NPA situation could give a bump to earnings in the future and normalise the PE.
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. The dividend yield is around the same levels in the last quarter, at 1.3 per cent. This is still close to the long term average of 1.5 per cent.
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.