Market And Economy

A Feather In The (Large) Cap?

DSP

Mar 18, 2025 3 mins

Summary

The Nifty 50's P/E ratio is nearing fair-value territory after a 20% decline, suggesting a moderate equity allocation in large caps. With slowing earnings growth and valuations normalizing, another 8-10% correction or rising EPS could make large caps attractive. The broader market still needs time to reach fair valuation.

At this rather rattling juncture in the Indian market’s trajectory, let’s take a look at what some useful equity metrics can tell us about where the market might go next.

A good place to start is the P/E (price to earnings) ratio, which is usually applied to individual companies but can also be applied to an index to get a broader, aggregate view on market valuation.

The P/E ratio of the Nifty 50 has been rising steadily for several years now. It averaged 17x from 2003 to 2013, and has averaged 22x between 2014 and now: an upward re-rating of 5 points. Currently, however, the Nifty 50’s P/E ratio is close to its long-term average, as can be seen below.

Source: NSE, CMIE, DSP. Data as of Feb 2025. For Feb 2025 we have considered March estimate GDP.

Is this a fair multiple to pay? In other words, should investors take the current valuation level as a cue to invest?

Well, one way to make a judgement about this is to consider the Return on Equity (ROE) for the index in tandem with earnings growth. This may not be the most pristine way of going about this, but it should yield a reasonable indication of how the market is currently placed.

Consider the tables below:

Source: DSP, Capitaline, Data As of Feb 2025

From its September 2024 peak, the Nifty 50’s P/E has declined by 20%, while that of the Nifty 500 has seen a sharper decline. At an ROE of 15%, and earnings growth of 14.5%, the P/E for the Nifty 500 Index still looks a bit rich.

It should be noted that earnings growth for the broader market is currently slowing down. If earnings grow in the 10%-12% range, then, considering an ROE of 15%, the market would be fairly valued when it trades at a P/E multiple of around 17x - 17.5x.

The potentially good news? The Nifty 50 is approaching fair-value territory rapidly: another 8%-10% price correction, or a sequential rise in EPS, or a combination of the two will get large caps there.

Thus, large caps are approaching a point that warrants moderate equity allocation, diluting the conservative stance that valuations have suggested for a long while.

The broader market, as represented by the Nifty 500, is still some way off from being fairly valued, but it seems to be heading in that direction. Once it gets there, the ability of valuations to influence equity allocation decisions will decline.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.

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