Mumbai: The price-earnings ratio (PE), a popular indicator of stock or index valuations, for the benchmark Nifty has dropped 33% in the past three years even as the index surged 52% in this period. Analysts said the decline in valuations is on account of strong growth in earnings.The Nifty's PE ratio, based on trailing earnings, has dropped to 22 times from 33 times on March 30, 2021. Analysts said the PE ratio suggests the Nifty is trading at fair valuations, which means the index is neither cheap nor expensive."The valuations have turned cheaper as compared to pre-Covid levels due to very strong growth in earnings," said Gaurav Dua, head - capital market strategy at Sharekhan. "Nifty has appreciated by around 85% in four years; in comparison, the EPS of Nifty has grown by close to 115% in the same period."109708175PE ratio, a widely used valuation measure by investors worldwide, shows whether a stock or an index is cheap or expensive. The plain vanilla interpretation of this measure is that a stock or an index having a high PE ratio is considered expensive or richly-valued. Similarly, a stock or an index with a lower PE ratio is considered cheap. When the index reached 15,000 levels for the first time in February 2021, Nifty's trailing 12-month PE ratio was 42. Since then, there has been a change in the methodology of the calculation. From March 31, 2021, the Nifty PE ratio has been calculated based on consolidated earnings of companies from standalone EPS earlier. Consolidated earnings of the top 10 Nifty companies were 24% higher as compared to standalone earnings in FY21. The subsidiaries contribute to companies' profits and valuations in a big way.The aggregate profit of Nifty 50 companies was about ₹4.6 lakh crore as of March 31, 2021, which grew 55% in two years to ₹7.09 lakh crore as of March 31, 2023. For the past 12 months, Nifty companies have posted a net profit of ₹7.92 lakh crore."Lower consolidated PE is due to higher growth in profitability in the last three years, led by pent-up demand," said Vinod Nair, head of research at Geojit Financial Services. "As business conditions return to normal, this trend is expected to bring valuations closer to their long-term averages."Nifty's current PE ratio at 22 times is still lower than the 5-year high average of 27."It's IT stocks and HDFC Bank which have kept a check on Nifty's PE ratio," said Siddarth Bhamre, head of research at Asit C. Mehta Investment Intermediates. "Among the top 10 heavyweights, IT stocks have seen growth in earnings while prices have not fared well in the said period. HDFC Bank has also been a major underperformer despite growth in earnings."Analysts said if the constituents in the index had not been shuffled, its PE ratio would have been cheaper."If the same set of companies that existed in the Nifty in FY18 had remained in the index, the PE ratio would have contracted to 20.9, which is at a discount of 9% to the current index PE," said Vinod Karki, equity strategist, ICICI Securities.In recent times, Britannia, Nestle, Titan, Tata Consumer, Divi's Lab, Apollo Hospitals, HDFC Life, and Bajaj Finserv, among others, were included in the index in place of low-PE stocks such as Indian Oil, GAIL, Indus Towers, Zee, Vedanta, HPCL, Aurobindo Pharma.
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