Q4-FY 03/11 Our view on NIFTY

Indian equity market in the last quarter of fiscal year March 2011, ended with a confusing note. Hit by various scams in PSU banks and Telecom industry, market reacted sharply in the month of Jan and Feb. However it showed a recovery mode in March and continues to do so. Inflation is a threatening effect on the market valuation which the Govt of India is not very effective in controlling it. But all these negatives didn't affect the market much. In our opinion, market is not cheap even after a fall in the first two months. We base our view on index valuation by three ratios :

1. Price Earning (P/E) 

Current P/E is 22.4x - means earnings yield for the market is just 4.5%. This is less than 10 years GOI bond coupon rate (8.25%). Assuming there is no growth in earnings of 50 stocks in NIFTY, we would get just 4.5% in equity index against risk free rate of 8.25%! For sure NIFTY is overvalued in terms of earnings.

2. Price to Book Value (P/BV)

 Price to Book Value is 3.75x. Going by the thumb rule, P/BV should be less than 1x for undervaluation. Again by this valuation metric, NIFTY is overvalued.

3. Dividend yield (%)

Dividend yield from NIFTY is just 1.06%. Generally anything above 3% would be considered as good along with low P/E under 10x - where the total yield would be minimum of 13% (3% from dividend and 10% from earnings).

By all these valuation ratios as well as what is happening in Corporate India, we believe that market is overvalued. So long term value investors should be patient enough for a possible crash. When it is happening, we can pick some of the valuable business at cheap price. So maintain patience - wait until others in the market gets panic.