After getting jumped 91% from March lows, Nifty is now trading close to all-time higher. This multi-month rally in the 50-stock index has turned the spotlight on valuations. However, domestic brokerage and investigation firm ICICI Direct mentioned that comparing PE multiples in isolation will not spell out the appropriate path or assessment as to irrespective of whether Nifty multiples are stretched or undervalued at this juncture. The brokerage firm mentioned that taking into account the wash-out overall performance of India Inc in the initial and the second quarter of the present fiscal year will deflate the actual earnings.
Change in Nifty constituents
Analysts at ICICI Direct think TTM PE (trailing 12-month price tag-earning ratio) and forward PE will shift to greater orbits the key explanation for it stems from the modify in Nifty constituents in the previous decade. The report added that involving March 2009 and December 2020, the weightage of sectors such as Oil & Gas, Construction, Metals and Telecom has fallen from ~60% in 2009 to ~20%. On the other hand, the weightage of sectors such as Financials, FMCG, IT, and Pharma enhanced from ~30% in March 2009 to 70% now.
“The change in contours in the Nifty composition logically shifts the PE orbit as well. This is well corroborated by the fact that trailing PE of Nifty in 2009-2014 averaged 17.1x. The average current PE multiples further expanded to 20.9x as the share of capital-efficient sectors such as FMCG, Financials, IT and Pharma have performed well,” they mentioned.
Better overall performance not captured
Along with this, the preference for earnings visibility and consistency have helped capital-effective sectors acquire weightage, and therefore trigger additional push in PE multiples. Further, supporting their argument, analysts at ICICI Direct mentioned that greater performing company segments inside current firms is not captured by present PE multiples. “There are 9 companies in the Nifty, contributing 32% weight, wherein valuations are based on Sum of the Parts (SoTP) methodology,” they mentioned.
Taking the instance of Larsen & Toubro, the report noted that segments of the firms like IT are expanding a great deal more quickly than the core company and therefore attract greater PE multiples. “So on a consolidated basis, the PE of the overall business will be higher than PE ascribed to core infra and engineering business,” they mentioned.
Nifty target elevated
Assessing the Nifty’s PE on a bottom-up basis, on the anticipated earnings overall performance and person target rates assigned for every stock, ICICI Direct has arrived at a forward PE of 26.2x FY23E basis. “Hence, in order to arrive at a fair value on the bottom-up basis, we take a 10-15% discount to our weighted average PE of 26.2x in order to account for future earnings downgrades and any other unforeseen macro risks which might risk earnings to come at a target PE range of 22x-23.6x,” the brokerage firm mentioned, consequently arriving at a fair worth of 16,300 for Nifty in the next 12-18 months.
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