By Vinay Ahuja, Executive Director, 360 ONE Wealth
In mid-September, the two benchmark stock market indices in India—Sensex and Nifty—breached psychologically critical marks. The BSE’s 30-stock Sensex crossed the 60,000 level and the 50-stock Nifty of the National Stock Exchange (NSE) entered the ‘adult’ territory as it topped the 18,000-mark. This was not the first time the indices had touched these levels. The Nifty had done so in January and then in April. The Sensex had also breached its respective level in those two months as also briefly in August.
The two indices went on to touch a record high in December, shooting past the previous peak of Diwali 2021, prompting investors to burst crackers to celebrate the achievement. However, the indices have seen profit-taking over the last few weeks and have declined over 5% since then. Various global factors continue to cast a shadow on the Indian market. The Western world is going through unprecedented inflationary pressures, due to commodity price inflation in the US and the impact of high energy prices in Europe because of sanctions and disruption in supply from Russia. Even though the crude oil price has moderated from the highs of June, it is still way above the comfort level, prior to Russia’s invasion of Ukraine.
This has prompted a hawkish monetary policy stance, as anticipated, by the US Federal Reserve. The US Fed has increased the policy rate in the US to the 4.25-4.5% range, the highest since 2008. The Indian central bank has gone a step further and surprised analysts by jacking up the policy rates by more than what the street was expecting in its previous sittings. Last month, it increased the repo rate again by 35 basis points (bps) to 6.25%, and the majority view of the monetary policy committee was to withdraw accommodative stance.
Investors are not just concerned about the impact from higher inflation due to oil and other commodities, but also due to the flight of offshore capital that has dragged the rupee to new lows. While the Indian currency has performed better than other emerging market and developed world currencies against the greenback, the slide would mean higher prices for anything imported. Since the Indian economy is a net importer of goods, this is not going to be reined in by policy rates alone, translating into more than a momentary problem for the RBI.
At the same time, technology service champions, which derive a big chunk of their revenue from the West, are now bracing up for what experts have pronounced as a clear recession on the horizon. With the ongoing severe wave of Covid-19 in China and some other markets, investors are also jotting in the risk of a fourth wave in India and its likely impact on businesses. But the valuation metrics of Indian stocks have changed over the last one year.
Indian share market: What has changed?
India Inc’s intrinsic value has changed materially since October 2021, when the benchmark indices hit record highs. One can look at various parameters to assess valuations, but fundamentally it comes down to what’s the trend with respect to earnings or the value of assets. In 2021, the companies were still in the process of coming out of the dark period of the Covid-19 pandemic. Over the last one year, as investors realised that the third wave was more benign than previously expected, the earnings profile and the balance sheet of Indian companies changed for the better. The price-to-book value (P/B) ratio, which seeks to weigh valuation relative to the book value of net assets, is considered a more robust way to assess valuation at a broad level by value investors.
The Nifty’s P/B ratio had crossed the ‘4’ mark for the first time in 13 years in January 2021. It kept climbing till October that year, when the index hit a new peak. At 4.63, the ratio was only lower than 2008 when the bull market had catapulted the valuation to over 6! The ratio came close to test this number again in January and April 2022, touching 4.61, when the Nifty breached the 18,000 levels. But when Nifty tested the same level on September 13, the ratio was around 4.19, almost 10% lower. This depicts how the value of assets held by the Nifty 50 companies has moved up in the interim period, making the index level more acceptable than a year ago or even five months back.
At 4.19, the P/B ratio was still higher than the long-term average of 3.6. The long-term average incorporates the spikes and the corrections associated with the dotcom boom (1999-2000), the subprime crisis followed by the collapse of Lehman Brothers (2007-08), the liquidity-led bull run before the pandemic, and the tech stock frenzy in recent years. As the indices climbed during November to hit a new peak on December 1, the valuation ratio too flared to hit 4.42. The ratio has slid since then due to the market correction over the second half of December. The P/B ratio has shrunk to around 4.19.
Overall, the stock market has absorbed some froth of the recent past as listed Indian companies boosted their balance sheets and the value of assets, partly as better earnings added liquid and other assets to the balance sheet. To borrow an analogy from the newfound consciousness around health, the market was bulky last year as well but was burdened with fat. It has worked out over the last year to convert some of that into muscle and is more solid now than before.