Are Indian Markets Overvalued or Undervalued?

Our domestic stock market is soaring high. Indian equity benchmarks Sensex & Nifty are hitting new heights. Sensex crosses 75,000 level & Nifty tops 23,000 levels. We see the Indian Market experiencing this kind of tremendous growth. Then the following questions definitely pop up.

Are Indian Markets Overvalued or Undervalued?

Is Sensex Overvalued or is Nifty Overvalued?

There has been a fuss around social media where some influencers advocate for profit-booking, suggesting that it might be prudent to lock in gains given the substantial rally and that we are in the year of the 2024 general elections. On the contrary, others believe that this rally is only the beginning, and there could be further upside potential deeming this to be India’s decade for growth.

But what is it that we retailers should do? Should we book our profits from the stocks and our Mutual Funds? Or should we continue to hold them?

In this latest updated article let us make a detailed study of the current situation of the markets and do both fundamental and technical analysis as to where exactly our markets are heading and what should be our course of action.

Let’s begin.

Table of Contents:

I. Fundamental Checks
1. The PE Check.
2. The Forward PE Check.
3. The Buffet Indicator Check.
4. The FII Impact
6. BEER ratio
7. Inflation Check:
II.Technical Check:

•  RSI Check:
• What can we derive from the above chart?

III. Undervalued vs Overvalued stocks
8. What’s our action plan?
9. Conclusion

I.) Fundamental Checks

There are a ‘n’ number of questions an Indian stock market investor would have about the valuation of the Indian Stock Market. We will strive to provide answers for all of this by calculating different parameters and by the end of it, we will confront the elephant in the room, whether the “Indian Markets are Overvalued or Undervalued”? Is Sensex & Nifty overvalued?

Let us now assess our market’s current position by analysing four distinct parameters. These parameters will serve as valuable indicators to ascertain the trajectory of our market and will facilitate us in making judicious and rational decisions based on whether the Indian Markets are Overvalued or Undervalued.

1.)The PE Check

The PE ratio is a widely used measure to assess stock valuations, and similarly, the Nifty indices also have their own PE ratio, representing the combined PE ratio of the top 50 stocks in India.

How PE Ratio is calculated?
PE Ratio = Stock Price / Earnings Per Share (EPS)

• PE vs PB Ratio
  Understanding a stock’s market worth with its earnings is possible with the use of a P/E ratio. However, you can evaluate the company’s stock valuation with its book
  value by using a P/B ratio.

Last 2 Years PE Ratio Analysis

It is important to analyse the past Nifty50 PE ratio to find whether the currently is Nifty50 “Overvalued or Undervalued?”. As shown below, over the past two years, the Nifty 50’s PE ratio has shown some interesting trends. In Jun 2022 it was at 19.67X.

Just one year later, it reached a peak of approximately 23.34 in Jul 2023 but then declined to 21.05 in Nov 2023. And it is currently inclining & trading at a premium of ~21.5 (May 2024). This indicates that the market is fairly valued right now, rather than being overvalued. Compared to July 2023, we are in a better position.

Any upturn can lead to an over-valuation zone.

Long-Term & Medium-Term

Furthermore, for the Nifty PE check, we conducted a comparative analysis of the Nifty PE levels with both long-term and medium-term averages, and the results show that the market is slightly feeling the radiance of heat. Despite the substantial market rally, the current position may trigger a correction in the short-term.

The valuations are not as stretched as much as it is being spoken about, indicating a more balanced and reasonable market state. But still early to conclude just by verifying the Nifty P.E. Ratio to know whether are Indian Stocks Overvalued or not.

(* The Government of India did not release the CPI inflation rate for April and May 2020 due to the nationwide lockdown induced by the Covid-19 pandemic.)

(Check the current Nifty50 PE Ratio)   

But…!

Will the past performance-impact or determine the future?

NO!

This past performance of the Indian Stock Market is a historical narrative and does not necessarily predict our future performance.

If you wish to enlighten yourself more on the future performance of the Indian Stock Market we would suggest to read our article on Revealed: Indian Stock Market Prediction for the Next 10 Years

Well, we have another metric to study how the future price to earnings will be and that is called the Forward PE.

2.)The Forward PE Check

The forward PE ratio uses the forecasted earnings per share of the company over the next 12 months for calculating the price-earnings ratio.

How to calculate the Forward PE Ratio?

It is calculated by dividing the price per share by forecasted earnings per share over the next 12 months.

As we do it for the Nifty 50 index, we put together all the EPS of the top 50 companies into this calculation and arrive at the forward PE.

How does the current performance of Nifty 50 forward P.E. stand when compared to 2021?

As of May 2024, the Nifty 50’s one-year forward Price-to-Earnings (PE) ratio is around 21.35. This is relatively close to its 10-year average, indicating that the market is currently fairly valued rather than overvalued.

Nevertheless, it remains significantly lower than the peak of 23 times observed in October 2021. Moving forward let us understand the relationship between P.E. Ratio and Returns.

PE Ratio & Return

What is a good PE ratio in Indian Stock Market? Based on research conducted by Ace Equities published in the Economic Times, it has been observed that whenever the PE ratio falls below 20x, then the Nifty 50 Forward P.E. Returns for the preceding year have been on the higher side.

This was evident when there were extreme movements in the index

January 2003, – PE 15x the forward return was ~88%.

2008-09 crash- PE was at an extremely low level and then the NIFTY 50 Forward P.E. Returns for the preceding year was over 80%.

Covid crash of 2020-Nifty PE fell below 20x. Then in the consecutive year. the NIFTY Forward P.E. return was around 70%.

On the contrary, P.E Ratio surged over 35x in 2021 , followed by a drop in Nifty.

So, whenever the PE falls below 15x, the benchmark has delivered an average 51.8% return over the next  year. When the PE is between 15 to 20x, the average return is 15.2%.

Currently, Nifty’s PE chart indicates that it is placed at ~21.5x. As per the metrics depicted in the graph, the probability of getting a sub-par return is high. Investing in this period involves high risk & it is not a conducive environment for a low-risk appetite investor or a new-bee investor.

3.)Buffet Indicator Check

This is another important factor that is checked for the market valuation.

What is a Buffet Indicator?

The Buffet Indicator consists of 3 factors namely,

• The total market cap of the listed companies in India
• The total GDP of India
• Total Assets of the Central Bank

Variations

There are 2 variations in the Buffet Indicator

• Ratio = Total Market Cap / GDP
• Ratio = Total Market Cap / (GDP + Total Assets of Central Bank)

Analysing The Two Variations

Though there is a debate as to which one gives a better view of the state of the economy, we will examine both approaches to assess our current scenario.

Scenario 1:

In the Market Cap to Indian GDP ratio, we divide the Market capitalization by the total GDP and arrive at the ratio of 100.24 under the original ratio as defined by Warren Buffet

Scenario 2:

We include the total assets of the central bank in our calculation combine the same with the GDP and then calculate this ratio. By this, the Nifty Market Cap to GDP ratio comes down to 90.68%.

Further, based on these historical valuations, the market valuation is divided into five zones:

Ratio = Total Market Cap / GDP	Valuation
Ratio ≤ 64%	Significantly Undervalued
64% < Ratio ≤ 82%	Modestly Undervalued
82% < Ratio ≤ 100%	Fair Valued
100% < Ratio ≤ 119%	Modestly Overvalued
Ratio > 119%	Significantly Overvalued
Where are we today (2024-05-24)?	Ratio = 100.24%

Based on these modified historical valuations too, the market valuation is split as follows:

Ratio = Total Market Cap / (GDP + Total Assets of Central Bank)	Valuation
Ratio ≤ 57%	Significantly Undervalued
57% < Ratio ≤ 73%	Modestly Undervalued
73% < Ratio ≤ 90%	Fair Valued
90% < Ratio ≤ 106%	Modestly Overvalued
Ratio > 106%	Significantly Overvalued
Where are we today (2024-05-24)?	Ratio = 90.68%

In both instance, we are in a good position and marginally above the fairly valued zone.

What can we conclude from these 2 scenarios?

Though there are limitations around the inclusion of only the listed companies and the applicability of this indicator to developing nations, this indicator can be considered to be one of the factors in determining the valuation of the market.

Consequently, according to this analysis, we can conclude that neither the Indian Stock Market Overvalued nor Undervalued, but is we are fairly valued in both methodologies.

4.)The FII Impact

What is FII?

FII is fondly referred to as the market movers, especially in a developing country like India.

How does FII affect the market?

They infuse capital into the market and can change the course of the market within months.

FIIs are single-handedly capable of driving individual stocks and benchmark indices.

They are investors with deep pockets of money with less control, looking for lucrative investment options.

The amount of money they can invest is impossible to replace by domestic investors or any.

How FII’s have Driven the Market?

There are many instances where the FIIs have been acting as the catalyst in the market movement. So definitely FII can plays huge role in how the Indian Stock market can perform in the coming future. By analysing FII data today we will get to know what has been FII.

This will help you get a fair idea of how dependent is Indian Stock Market on FII.

Milestones Of FII

The FII pulled out almost Rs.65000 Cr during the Covid slump in March 2020 and we all know what happened after that. They have also led the recovery post covid.

During the period from Oct 2021 to July 2022, FII was on a continuous selling spree.

They have pulled out a whopping 390K Cr from the Indian stock market and what has been the impact of this brutal sell-off, a fall for Nifty from the all-time high of 18600 until 15000.

Role Of FII in the Indian Market

This confirms that FIIs play a pivotal role in propelling the Indian markets forward. This sell-off may be attributed to Macroeconomic factors, soaring inflation, and crude oil prices as well as the rupee depreciation.

Date	FII – Net Purchase / Sales
Dec-23	31,959.78
Nov-23	3,901.82
Oct-23	-29,056.61
Sep-23	-26,692.16
Aug-23	-20,620.65
Jul-23	13,922.01
Jun-23	27,250.01
May-23	27,856.48
Apr-23	5,711.80
Mar-23	1,997.70
Feb-23	-11,090.64
Jan-23	-41,464.73

FIIs have remained net sellers throughout August, September & October 2023. This FIIs selling in October 2023 is the highest since January 2023. In January 2023, FIIs had sold out Indian stocks worth ₹41,464.73 crore.

One of the major reasons for this spelling spree is, that US 10-year bond yield rose to nearly 5% (4.98%) for the first time since the global financial crisis of 2008. This makes them pull out from risky assets to bonds and other safe-haven assets. Also, the Global economic slowdown is a major concern for FIIs, making them more risk-averse.

FIIs changed their trade pattern in December because the US treasury yield has come down from 5% to nearly 4%. The Indian equities market valuation is also attractive when compared to other emerging markets. This makes them an appealing place to divert their funds.

Where are we now?

The Inclusion of Indian Bonds to Global Bond market indices has been made a worldwide recognition. This move shows that the Indian financial market has gained a mature status. The impact is evident through increased foreign investment in December.

India is positioning itself as an attractive destination for global investors. India’s stock market value surpassed Hong Kong’s, securing its position as the seventh-largest in the world by the end of November 2023. The Nifty 50 index reached a historic high of 22,967 on May 23, 2024, marking a significant milestone for the Indian stock market. If you ask whether the Sensex is overvalued or, undervalued., The answer is, that Sensex also hit a record high of 75,582.

A Sustained fall in the US bond yield added to global interest rate dynamics and resulted in the active participation of FIIs & FPIs. This is the main reason for the continued rise in the Indian Market.

So, what is the underlying message here?

The BSE Sensex & NSE Nifty closed at a record high in May. While looking at the figures, it looks impressive. However, prolonged upward trend may raise a concern about over valuation of stocks in the Indian Stock Market.

FII’s were net buyers for a major part in 2023. However, since 2024 began, they’ve become more careful because of the upcoming general elections. It makes sense for them to withdraw money during this uncertain time. After the election results are out, there’s a good chance that FIIs will start investing more money again

The overvaluation or undervaluation of the stocks in the Indian market is also influenced by global factor, any negative cues could lead to a corrective phase. The market’s reaction will depend on certain trends Viz. global macro trend, Inflation trend & Central bank’s rate trend.

5.)BEER Ratio

This is another parameter that is used to determine the direction of the market.

What is the BEER ratio?

BEER ratio stands for “Bond Equity Earnings Yield Ratio”.

How the BEER ratio is calculated? The ratio is determined by dividing the 10-year yield of government bonds by the current earnings yield of Nifty. The denominator here, the earnings yield is also the inverse of the PE ratio.

A BEER ratio of 1 is considered to be a fair value and the market is said to be fairly valued.

A value greater than 1 is said to be overvalued and less than 1 indicates an undervalued market.

What is the use of the BEER ratio?

Generally, the BEER ratio is used in asset allocation to decide whether to invest in Equity or debt based on the outcome of the calculation. When considering asset allocation, a value greater than 1 indicates a preference for investing in bonds/debt funds, while a value of 1 indicates the investment is directed towards equity.

BEER Ratio of India

In India, 10 Years Government Bond has a 7.235% yield

India’s equity market yield is around 4.56%

“So, India’s BEER Ratio amounts to 7.235/4.56=1.58”

This typically indicates an overvalued market. However, to gain a deeper understanding, it is crucial to analyze the historical values of the BEER ratio.

BEER ratio of India – Values from The Past

Based on data from 2020, the long-term average of the BEER ratio for India was approximately 1.6 over two decades. This suggests that a value of 1.5 BEER Ratio of India may be considered a fair valuation, given the historical context.

Source: ETMoney

6.) Inflation Check

“Inflation plays a critical role in influencing our purchasing power”.

Put simply, it is a metric that leads to the gradual increase in prices of goods and services over time, impacting consumers’ personal finances, spending habits, and buying decisions.

As inflation rises, buyers experience the effects, which can be felt in their ability to afford goods and services in the market and vice versa.

Inflation Data vs Market Data

Though the correlation between the inflation data and the market data is not a straightforward one, we can derive some conclusions by just studying the inflation rates over the past few months and deciding for ourselves.

Reduced inflation means increased spending power at our disposal.

Stock Market Now!

In India, inflation has experienced a downward trend in recent months from 5.66 in 2023 to 4.85 in 2024, alleviating some of the pressure on the Reserve Bank of India (RBI) to increase interest rates. The Reserve Bank of India (RBI) announced a pause on any revision to the repo rate. It kept the benchmark repo rate unchanged at 6.50% for the third consecutive time amid a slowing global economy and spiking inflation on the home turf.

RBI tries to curtail inflation & aligns it with a target of 4% in the coming months. However any further rise in prices will have an effect on the stock market in the short to medium term.

The markets have reached an all-time high, and inflation is bobbing, while the other essential parameters align to indicate favourable prospects for the long term.

Fundamental indicators such as the PE ratio, Buffet indicator, FII inflow, inflation checks, and BEER ratio collectively point toward a market that is slightly overvalued, the main factor behind this being the general elections 2024. So did we finally get the answer to whether are Indian Markets are Overvalued or Undervalued?

But, the conditions seem conducive to sustained growth and investment only in the long run.

To further strengthen our conviction let us now check from a technical perspective as well.

II.)Technical Check

RSI Check

What is RSI?

The Relative Strength Index (RSI) was introduced in 1978 by technical analyst J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems.

The relative strength index (RSI) is a momentum indicator utilized to assess the speed of recent price fluctuations to gauge whether a stock is likely to experience a surge or a decline in value.

How does Nifty RSI investing work?

How to predict the growth or decline of a stock using RSI?

When the RSI goes below the horizontal 30 reference level, it indicates a bullish signal and is considered to be oversold, implying potential price growth.

Conversely, when the RSI goes above the horizontal 70 reference level, it indicates a bearish sign, suggesting an overbought position which may lead to a potential price decline.

What can we derive from the above chart?

The provided chart depicts the weekly timeframe setup on Trading View, featuring the 14-period Relative Strength Index (RSI) as the selected indicator, which calculates price changes over the past 14 periods.

Based on this setup, we observe that the RSI indicated overbought conditions in both February and October 2021, and January 2024, preceding subsequent market declines.

What is the current scenario of RSI in Dec 2023?

RSI reached the 70 -80s level twice, in July & December. This shows that the market is in the over bought zone. Despite that, there was a dip in October, reaching 20-30s level.

In the current scenario, the RSI is much lesser and is below the moving average of the RSI(14), and expected to reach the median in the near term. So, we cannot rule out the possibility of a mild correction in terms of price.

Is the current Nifty index overvalued? When combined with the fundamental analysis we previously discussed, we can deduce that Nifty’s valuation is scaling up and any global or domestic headwind may impede the momentum.

Examining the market’s overall price-to-earnings ratio is one of the greatest ways to spot an overvalued market. The method used to calculate this ratio is the same as that used to calculate it for a single stock. As many analysts use this figure to assess the state of the economy, it is readily available in the market.

 How to find if a stock is undervalued or overvalued? How to calculate the intrinsic value of a stock? How to check the Nifty PE ratio? 

The basis of all of this is knowing what are Overvalued and Undervalued stocks. Before reading an analysis of market valuation, it is always better to brush up on the basics.

Let’s start by comparing overvalued stocks with undervalued stocks.

Undervalued vs Overvalued Stocks

Okay. So, what are Undervalued and Overvalued stocks?

The relationship between a stock’s current market price and its estimated intrinsic worth is referred to as Undervalued or Overvalued stocks.

Undervalued stocks are those that are trading at a discount to their intrinsic value, which means there is room for the price to climb until it reaches its actual value.

Overvalued stocks, on the other hand, are stocks that are trading higher above their intrinsic value, indicating that the market has overpriced the stock. Before checking whether “Is Indian Markets Overvalued or Undervalued?” Isn’t it essential that you should be thorough with the basics to be clear with the subject matter?

One way in which we can draw parallels between the stock market and Mutual Fund investment is the existence of similar Undervalued Funds. Investors often get confused between Undervalued and Underperforming funds in Mutual Funds. Refer to the below video for a clear understanding.

8.)What’s Our Action Plan?

The first rule of compounding is to never interrupt it unnecessarily

-Charlie Munger

Now that we have learned that our markets are not as expensive as we had thought earlier what should our course of action be?

When we posted this question earlier in the introduction, we did not have an idea as to how the markets are prevailing, but that’s not the case now.

The answer is….

Do Not Stop! Persist…

“Keep investing in your SIP, regardless of whether the markets are doing well or not”.

Before and after elections, the stock market can become very unpredictable, making investors worry about their money. But even when things seem uncertain, there’s a smart plan that works: keeping your investments for a long time. Instead of getting stressed about elections, we should  focus on the longer objective and hold fort during the rough seas.

As the saying goes, “It’s time in the market, not timing the market,” that ultimately leads to financial success.

9.)Conclusion

Here’s an interesting fact: if you stay invested for the long term, your daily gains might even match the value of one entire month’s SIP

This remarkable growth is due to the magic of compounding, which can only be realized when you remain invested over an extended period.

“Time in the market is more important than timing the market”.

So, embrace the power of long-term investments to witness the incredible benefits of compounding.

Are you interested in investments and spend your time relentlessly searching for a financial plan on social media sites like Quora, Facebook, Twitter, etc?

A professional Financial Planner is an expert in clearing your doubts!

Happy Investing!