Nifty valuation to become 12% cheaper from March 31

K.S. Badri Narayanan Kumar Shankar Roy Updated on March 02, 2021

NSE to consider consolidated earnings to calculate PE ratio

Come March 31 and India's equity investors will have something to smile about. The valuation of India's benchmark equity index Nifty 50 is set to get cheaper by 12 per cent. Want to hear the real good news? The index will get less expensive, without the market actually falling.

This cheaper valuation for Nifty 50 is possible due to a small but a key rule change done by the NSE index management that will henceforth use consolidated earnings of Nifty 50 companies as against the current practice of considering standalone numbers.

Consolidated numbers include aggregated reporting of a company's entire business including subsidiaries. Only in cases where consolidated financials are not available, standalone financials will be considered, an NSE statement said.

The Nifty 50 index's PE valuation is set to fall from a rich 40 times based on standalone earnings to a modest 35 times when the consolidated figures are included.

Here is the math

Currently, the Nifty 50's Price to Earnings ratio (PE ratio is a measure of valuation) is calculated by taking into consideration earnings (including profits and losses) reported by each index constituent in trailing 4 quarters standalone financials. So, the Nifty 50’s current PE ratio is 40 times. This is based on index value of 14,761 (March 1 closing) divided by the standalone earnings of nearly ₹364 (Dec 2019 quarter, March 2020 quarter, June 2020 quarter and December 2020 quarter).

As per Bloomberg, the Nifty 50 consolidated earnings for last 4 quarters are about ₹421. So, the Nifty 50’s PE ratio would drop to 35 times from March 31 based on index value of 14,761.

With India Inc. having invested substantial money in units and having waited for those businesses to operationally stabilise, subsidiaries of many companies are no longer a headwind they used to be a few years ago. In fact, they are a tailwind as a majority of companies have better earnings when taken at a consolidated level. Hence, not just Nifty 50, many key large cap indices such as Nifty next 50 would likely have higher earnings and show lower PE ratio.

39 stocks to turn better

Mandatory reporting of quarterly consolidated data provides a realistic picture of total earnings. This is because many companies such as Sun Pharma are profitable at group level and so consolidated earnings for such companies are much higher. In fact, if the consolidated number is taken, as many as 39 stocks such as HDFC Bank, SBI, ICICI Bank, L&T, Adani Ports & SEZ, Hindalco of the Nifty 50 will show better profit compared to their respective standalone number.

But there is a flipside to it. Nine companies of Nifty 50 will be better off using standalone number. "Tata Steel is profitable on a standalone India business level. But consolidating loss in global subsidiary Corus Plc. hurts its earnings considerably," according to a DSP MF note.

Still costly

There are other implications as well. Some investment products with a value-conscious style of investing usually put money in stocks where the rolling twelve-month PE ratio is lower compared with indices such as Nifty 50. With the benchmark getting cheaper from March 31, finding stocks cheaper than the Nifty 50 could be harder.

Also, the imminent drop in Nifty 50’s P/E ratio valuation does not make the index cheaper globally. Even at 35 times trailing 12-months earnings, the Nifty 50 index will continue to be one of the most expensive globally. For instance, China's SSE Composite trades at 19 times, America's Dow Jones Industrial Average trades at 28 times, and Japan's Nikkei 225 trades at 34 times.

Published on March 02, 2021
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