The Covid-19 pandemic continues to rage, taking a heavy toll on lives and economies. But the Indian benchmark, the Nifty50, has gained 41 per cent from its March lows; other global markets have also charted a similar reversal. This sharp rally, against the backdrop of weak earnings, has taken valuation of all global benchmarks to pre-Covid levels.

Experts, however, say that investors should not worry too much over near-term weakness in earnings and instead take a long-term view on equity investment.

The correction in March had removed much of the froth in stock valuation. The Nifty50’s trailing price to earnings multiple (PE ratio) had declined from 28.6 times in January this year to 17.1 in March. But the market rally since April has taken the PE multiple back to pre-Covid levels, at 28 times. The spike in the PE multiple is, however, much sharper in other global benchmarks such as the US’ S&P 500, Germany’s DAX, China’s Shanghai Composite and Brazil’s Bovespa index. The current PE multiple of these indices is much above the January levels (see table).


The PE multiple, however, does not tell the whole story. “Looking at earnings over the next one year can be misleading as the economy is going through a downturn,” says Mahesh Patil, Co-CIO, Aditya Birla Sun Life AMC. “In the current environment, instead of a short-term one-year view, it would be best to take a three-year view as the economy would have normalised by then.”

Prashant Jain, ED and CIO, HDFC AMC, points out the March fall created very good buying opportunity. “Historically, when Nifty50 returns decline below 5 per cent CAGR (compounded annual growth rate) over a 10-year period, good returns have followed over the next 3, 5 and 10 years. Due to the coronavirus, 10-year Nifty50 returns were at 5 per cent CAGR in May, after 15 years.” Investors seem to have been quick to grab this opportunity.

Price to book value

The price-to-book-value ratio or market-cap-to-GDP ratio are the other gauges to see if market has become pricey. But the rally over the last three months has made stocks expensive based on these metrics as well.

The P/B ratio of Nifty50 hit the high of 3.81 in January and is currently just 18 per cent below this level. The S&P 500 has, however, surpassed its P/B ratio of January and is currently at a record high of 3.6.

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The market-cap-to-GDP ratio of Indian markets had also fallen to 51 in March from a high of 79 in January this year. Such low levels were seen only in times of deep crisis such as in 2008. But the ratio is back at 70 now.

The way ahead

What’s the way ahead for investors? “Covid-19 is a once in a life time event that resulted in severe temporary stress. However, the impact of one such year on intrinsic value of business is minimal. Like in the past, the world should limp back to normalcy and neither Covid-19 nor lockdown should be making headlines after some time,” says Jain.

“If we look at the next three-year timeframe, Nifty earnings are expected to contract in FY20 and FY21 but record a strong recovery in FY22 and stabilise in FY23. So, for a three-year valuation, we will assume a CAGR of 8 per cent for Nifty earnings from FY19 (actual) to FY22 (estimates) which is in line with the earnings CAGR over the past five years and a stable 12 per cent in FY23 (estimated earnings),” says Patil.

He adds that as companies re-design their business processes to take advantage of technology, remove inefficiencies, and reduce costs, earnings growth can improve faster than expected and potentially surprise on the positive side. This has also been evident in the past wherein earnings growth has been strong after previous crises, as companies focussed on reducing costs and managing their working capital.