Valuation benchmarks might have to change

While discussing the present state of affairs in the markets, especially the valuations, two
statistical parameters are used most often – (1) The price to earnings (PE) ratio of the
benchmark (e.g., Nifty50) and (2) the market capitalization to GDP ratio (popularly known
as Warren Buffet indicator).

Both these indicators may soon lose their relevance, particularly in the context of Indian
markets.

In next couple of years a large number of new economy stocks may get listed. Many of the
new economy stocks that listed earlier may get included in the benchmark indices.
Obviously, the old economy stocks, especially PSU and cyclical commodity stocks will pave
the way for these new economy stocks. The point here is that the new economy stocks are
valued at multiple of revenue not profits.

For example, it is expected that in the next Nifty reshuffle Avenue Supermart (198x PE) or
Info Edge (500x PE) may replace Indian Oil Corporation (5x PE). This will obviously inflate
the composite valuation of Nifty in PE ratio terms. At some point in time Reliance Retail
(100x PE), Reliance JIO (150x PE), Zomato (200x PE), PayTM (150x PE) Indiamart
Intermesh (80x PE) etc shall find place in the benchmark index at the expense of Coal India
(7x PE), BPCL (8x PE), NTPC (7x PE), Power Grid (9x PE). Assessment of market valuation
through Nifty PE ratio would become totally meaningless at that point in time.

The Warren Buffet indicator has already become less relevant in the case of Indian markets,
in my view. This indicator completely ignores the rise in private equity investments. In
Indian context for example, the equity investment in self owned enterprise and home equity
has risen sharply in past one decade, as compared to the decade prior to that. Besides, the
size of unlisted private businesses has increased significantly. Factor in the estimated
market value of Amazon India, Vodafone India, PayTM, FlipKart, Honda India, Hyundai
India, LG India, Samsung India, Apple India, etc. and you will find this ratio running much
higher than what the present statistic might suggest.

So the present argument that Indian market is “expensive but nowhere closer to bubble
territory” based on historical PE ratio trends, may become totally redundant. The market
participants might have to evolve new parameters for valuing the market that would be
appropriate in the evolving scenario.

Till then, Nifty50 is trading above 1SD 12 month forward PE and GDP to market cap has
crossed the threshold of 100%.

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Author: Midas Finserve

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