Nifty PE Ratio Chart

Methodology

The investment action suggested by the Nifty VMI has been derived based on analysing over 20 years’ worth of data on the Nifty PE ratio, the Nifty PB ratio and different momentum indicators of the Nifty 50 index. 

• Valuation Indicator: This indicator has 4 zones for the Nifty PE Ratio. The green zone is when the Nifty PE ratio is at the lower end of the range based on historical PE levels. The yellow and orange zones come into play when the Nifty PE ratio moves out of the low comfort levels into the more expensive zones. The red zone is, obviously, when the Nifty PE ratio reaches expensive levels. To test the effectiveness of this indicator, we took the daily consolidated Nifty PE Ratio for the past 20 years, analysed the trends in the Nifty PE Ratio along with the Nifty PB ratio. The algorithm used for determining the cut-offs is dynamic to help consider structural shifts in the Nifty PE ratio levels.
• Momentum Indicator: This indicator considers moving averages of different timeframes to gauge whether market momentum is strong, weak or somewhere in between. The model uses a combination of short-term and medium-term moving averages of the Nifty 50 to classify the level of market momentum.
• Investment Indicator: This indicator combines the current Nifty PE ratio, the valuation zone, and the strength of momentum. We designed this indicator based on the quantum of returns generated in different timeframes, on all possible combinations of the Nifty PE ratio and momentum that the past 20 years have thrown up, and on the probability of losses. 

Do note that the indicators above are all based on the Nifty PE ratio and not based on the broad market. Always consider your risk level and timeframe before making any investment. For more detail on how to read the three indicators above, please go here.

Key points to note on the Nifty VMI

The Nifty VMI is an extremely useful market mood and investment indicator. However, there are a few points to note: 

• The Nifty VMI is based on the Nifty 50 PE ratio and momentum alone. The indicator is based on past return and risk trends in the market at different valuations and momentum levels and how the markets will behave if those trends repeat themselves. While the Nifty 50 is definitely a broad market indicator, some market segments such as say the mid or small-cap segment may behave differently in both returns and downsides compared to the Nifty 50. 
• The Nifty VMI is not an indicator to book profits, sell, or exit your funds and stocks. It is an investment indicator only.
• The Nifty VMI considers returns of the Nifty 50 index to gauge whether it is the time to invest in the equity market. It is not a call on any specific stock or fund. It tells you whether you can invest in equities now. You will have to pick your own stocks or funds or ETFs to invest in or use our recommendations - Prime Stocks or Prime Funds 😊
• The Nifty VMI’s risk-return calculations were done on a lumpsum basis alone and is ideally suitable for such investment decisions. So you can use them for stocks that you are in your buy list. If you are investing through SIPs, you will be already investing at different market levels, reducing the timing risk, and averaging costs. Therefore, the Nifty VMI can be less effective. You can at best decide to deploy additional lump sums other than the SIPs you are running, when our indicator suggests that it is a good time to invest. 
• Always consider your risk level and timeframe before making any investment. 

What is PE ratio and how is the Nifty PE ratio calculated?

Price earnings ratio (PE ratio) is the rupee value that you are willing to pay for every rupee of earnings of a company. 

When the price of a stock is divided by the per share earnings of a company, you get the PE ratio. The same when applied to the Nifty 50 stocks becomes the index’ PE ratio.

The PE ratio is considered a key valuation metric to know how expensive a stock is in relation to its peers. Since the Nifty 50 is a bellwether index, the Nifty PE is used as a gauge to know if markets are expensive or cheap.

What you find above is a Nifty PE Ratio chart which gives a complete history of this critical indicator since 2000. According to the NSE website, the Nifty 50 PE ratio is calculated as follows:

Formula: Index market capitalization / Gross earnings

• Index market capitalization of the index constituents is the sum total of the outstanding equity shares or units considered for index computation multiplied by the last traded price of each index constituent adjusted for factors such as free-float, capping factor etc. depending upon the index methodology
• The earnings (including profits and losses) reported by each index constituent in trailing 4 quarters (standalone financials) are cumulated and adjusted for factors such as free-float, capping factor etc. depending upon the index methodology to arrive at the gross earnings.

Two things to know about the Nifty PE ratio chart

While the Nifty PE ratio is a good gauge for whether markets are too expensive to enter, there are two aspects to why it becomes important to take other fundamental metrics and valuations into consideration in addition to the Nifty PE ratio for investment decisions.

#1 PE can alter based on sector composition

When it comes to valuing companies, all sectors are not born equal. Markets assign premium valuations to sectors seen to have predictable earnings prospects and high shareholder returns such as FMCGs, IT and retail banks. Sectors with cyclical fortunes such as oil and gas, metals and mining and commodities usually trade at low PEs, even in good times.

Now, thanks to active index management, the Nifty 50’s sectoral composition tends to change quite drastically over time. This makes PE comparisons over time tricky. For example, when the index is overweight on cyclicals such as oil and gas, construction or metals, the Nifty PE may seem lower than when the index is dominated by FMCG, IT or financial services which traditionally command a premium. Hence, taking cognizance of sectoral changes in the index is important.

 #2 The denominator can result in conflicting signals

When assessing a stock for investment, we don’t look at its PE in isolation but also at trends in earnings in recent years, to see if the valuation is off a low base or a high one. For a company that is just turning around from losses to profits, for instance, a high PE may be irrelevant. The same logic applies to the index too. The PE for the Nifty50 needs to be interpreted based on whether the companies in it are coming off a period of high or low earnings growth. When the Indian market peaked out at a Nifty PE ratio of over 28 times in January 2008 Nifty companies had managed an earnings growth of 21 per cent in the preceding five years. However, for the same PE, if the earnings growth of Nifty companies is lacklustre, then may have conflicting views. If you’re a pessimist, you can cite this as evidence that the bull market in the last five years has little basis in fundamentals. But if you’re an optimist, you can also believe that with mean reversion, the earnings are likely to rebound at some time.

This article by Aswath Damodaran, Professor at the Stern School of Business at New York University, will clearly bring out the limitations of PE as a valuation assessment metric. He also brings out the dichotomy of a higher PE ratio for cash rich companies and a lower PE ratio of debt laden companies and why this can lead to misinterpretation. You can also read our article on whether you should dynamically alter your asset allocation based on the Nifty PE.

General disclosures and disclaimers