Low price-to-earnings stocks: The secret sauce in Nifty's earnings recipe

'A MIRAGE': Beyond the index's surface, the Indian market reveals full-to-frothy valuations

Given the strong market momentum, the benchmark National Stock Exchange Nifty has reached record highs more than a dozen times in the past month.

Even though the price-to-earnings (P/E) multiple of the 50-share blue-chip index, at 22 times its estimated earnings for 2024-25, is still considered ‘reasonable’ compared to historical levels, it makes more sense to analyse the valuations of individual companies, given the wide dispersion in P/E ratios.

Interestingly, stocks with multiples below the index valuation are contributing the most to the profit pool.

“The Nifty 50 index is a bit of a mirage,” say Sanjeev Prasad, Anindya Bhowmik, and Sunita Baldawa, equity strategists at Kotak Institutional Equities, in a note.

“A superficial view of the Indian market is typically based on the valuations of the Nifty 50 index. The index may be reasonably valued in the context of historical valuations and bond yields, but most other parts of the market are trading at full-to-frothy valuations after a massive rerating in their multiples in the past two to three years,” they add.

They highlight that the P/E multiples of stocks that have derated have contributed to the bulk of the incremental profit pool for the Nifty 50 between 2018-19 (FY19) and 2023-24 (FY24).

About two-thirds of the incremental net income of the Nifty 50 over FY19-24 has come from companies in relatively low-valued sectors such as banks, diversified financials, information technology services, and metals and mining.

The P/E multiples for these sectors are largely below 20x. Currently, these companies account for about half of the weight of the index. The other half accounted for 34 per cent of the incremental profits.