How To Calculate Whether Nifty50 Is Overvalued?
A quick calculation to check whether Nifty50 is overvalued.
Hi š,
I wanted to do the calculation of Nifty50 index with my last post, but it somehow skipped my mind.
Please read this in conjunction with my last post titled: 2 Numbers To Understand While Investing In Stock Markets
I will post my Kotak Bank and Nuvama wealth valuations soon.
PS: You can check my last post on Bajaj Financeās fundamental valuation here.
Note: This is not a recommendation, but an explanation on how to calculate whether an Index is overvalued or undervalued.
I donāt know what is it with Indian markets. The data is simply just not there.
I was checking Nifty50 earnings projections for next 3-5 years, I could not find any relevant post at all.
If you happen to know a relevant website or an article, please do share.
When I was trying to calculate Indiaās implied ERP (explained in last post), the same situation existed. I had mailed a VP at NSEIndices, the company which runs NIFTY50 index.
I told him that S&P 500 provides the buyback data and dividend data on a quarterly basis. This data, if available in market points or index points basis, can help us in calculating the implied ERP for Indian markets directly.
I sent him even the format in which S&P500 maintains the data.
He simply told - āWe dont maintain this dataā.
I donāt get it.
Why donāt they maintain it? Most companies in mature markets have moved onto buybacks as a way to return the wealth to the shareholders.
When a company gives you dividends, you are taxed twice. Once at a company level, and dividends are considered short term gains, so the receiver has to pay the taxes on them again. š«š
In India, the taxes are high and we as taxpayers do not get any advantage of paying these taxes.
Anyway, I feel that all companies should move to buybacks and NSEIndices should start reporting this data. If they can report dividends, they can report buybacks too.
In our last post, we discussed a lot on Risk-Free rates and Equity Risk Premiums.
We got the value of Cost of Equity(COE) for India, in dollar term as 11.82% and in Indian Rupee as 13.9%. I showed how to calculate these numbers in detail.
Let us now try to understand whether NIFTY50 is overvalued or undervalued.
Let us check what is the current EPS in index points or market points. Trendlyne reports the value at 1032 index points, with index at 21957 points.
We need to understand what the analyst are projecting the EPS growth in future years. Livemint mentions that the EPS will grow at 16% in FY 24-25. I could not find a 3-5 year growth projection. Please do share if you guys happen to have some analyst projecting the data for next 3-5years.
We will consider a 10-year evaluation window, since we calculated our COE for the same period at 13.9%.
For the 2 years, we will consider the NIFTY50 to grow at 16% and then slowly decrease the growth rate to 6.21% which was the risk-free rate of India we calculated in our last post.
Can this assumption be wrong? Oh hell yeah, it will be wrong. But I donāt have data which can help me here at the moment. š
Next, let us try to see what the ROE of NIFTY50 has been. This article shows the value to be more than 15% and in FY25 to reach 17%. Let us proceed with that.
We will assume that ROE of 17% is maintained from 1st till the final year. The US S&P 500 ROE aggregated for last 10 years is around 17%. (Download US data set from here under the header Return measures)
From Fundamentals, Growth in EPS = ROE x Reinvestment Rate.
Since, we have growth per year for next 10 years from point 4, and we have ROE per year from point 7, we can calculate the reinvestments and subtract from earnings to get our Free cash Flow to Equity
Once we have these values, we can discount by COE to get the Present value of these Free cash flows. We will assume that in terminal year, the CRP of India goes to 0% and the terminal COE becomes 10.61% : 6.21% (RFR) + 4.40% (ERP)
Based on the above calculations, we get the PV of index at 20517. The current value of Index is 21957.
Looks like the index is overvalued by around 7% based on our assumptions.
I have attached the Excel working for your reference. Feel free to change parameters and assumptions as needed.
I apologize for not clubbing it with my last article.
It simply skipped my mind.
Thank you for reading.
I hope you found this post useful.