As Sensex, Nifty hit new highs, here’s what the P/E ratio tells us about the markets

India’s two principal stock market indexes—the BSE Sensex and the Nifty50—are at record highs. On Wednesday, the Sensex crossed the 56,000 level for the first time while the Nifty50breached 16,700.

Although the market is trading at lifetime highs, retail investors face the vexed question that rears its head each time the indexes are buoyant: Is the market too expensive to put in fresh money or should they wait for a fall?
Analysts suggest that investors should look at some key metrics before they decide on whether they want to take fresh bets or hold off till the market corrects. 

P/E Ratio

One key factor to consider is the price-to-earnings (P/E) ratio. The PE ratio essentially indicates how many times the actual or anticipated annual earnings the stock of a company is trading. It shows whether a stock is overpriced or underpriced, and whether it is worth investing into. The P/E ratio is a function of the anticipated earnings growth that a company could see in the quarters and years going forward. 

A counterintuitive trend

As of August 13, the Nifty was trading at a P/E ratio of 26.51x. This is actually lower than the 42x levels in February.
So, why has the P/E ratio fallen when the markets are at record highs?
Counterintuitive as it may sound, there actually are good reasons for this fall in the P/E ratio in the last six months. 

For one, a change in how the ratio is actually calculated. Earlier, the P/E ratio for Nifty was calculated based on standalone earnings per share (EPS). Now, it is calculated based on the consolidated EPS. This makes a big change, as it takes into account earnings of unlisted subsidiaries. 

Second, India Inc has seen a growth in earnings over the past several months since the economy has opened up after the national and myriad regional lockdowns disrupted it throughout 2020 and the beginning of 2021. Analysts say that since February, investors have seen earning announcements of two consecutive quarters, and the numbers have been looking up. 

“Since February 2021, we have had the advantage of two quarters of earnings announcements, and they are on the higher side in comparison to the previous quarters,” Gopal Kavalireddi, head of research at FYERS Securities, told Moneycontrol. 
 

Liquidity and future outlook

Yet another factor that should be considered is the liquidity situation and how the future looks. 
Liquidity is essentially a measure of how readily deployable cash is available. Analysts say that such levels of liquidity influx have not been seen before in the Indian markets. 

Will the P/E ratio continue to fall? 

Market watchers certainly think so. They say that as political tensions between India and China have eased, at least for now, and the prospects of future earnings look good, the P/E ratio should continue to inch lower. 
Shrikant Chouhan, executive vice president at Kotak Securities Ltd, told Moneycontrol, that the Nifty is trading at 22.4 times the projected earnings of 2021-22 and 19.5 times the estimated earnings of FY23. He expects Nifty50 earnings to grow by 29.2% in FY22 and by 14.8%the following year.
“From now, till the end of FY22, we expect modest returns from the Indian market, considering the strong economic recovery and gradual increase in global and domestic bond yields,” he said. “By the end of FY22, investors would start discounting FY23 earnings.”