The Nifty PE ratio (Price to Earnings ratio) computes the average PE ratio of the 50 companies that comprise the Nifty 50 Index, and the terms Nifty PE and Nifty 50 PE are interchangeable. Nifty PE ratio assists in determining the current valuation of 50 companies listed and gauging their price in relation to their total earnings. Nifty PE is used as a gauge to know if markets are expensive or cheap, but before that let’s understand what is a PE ratio.

What is Price to Earnings (PE) Ratio? 

PE ratio is share price of a stock to its earnings per share (PE ratio = Share Price/Earnings per share). Price to earnings tells what is the amount an investor is ready to pay for one rupee profit earned from the share invested in. For example, if a company’s PE ratio is 36, it means that investors are willing to pay INR 36 for every rupee profit earned by the company.

Similarly, if the Nifty PE ratio is 18, it means that investors are willing to pay INR 18 for every rupee profit earned by all of the companies in the Nifty 50.  

What is Nifty 50 PE ratio?

The current Nifty PE ratio today as on 25 August 2022 is 20.92. Nifty 50 PE is an indicator of stock market health. PE of Nifty 50 is an indicator of the general valuation of the index. When the Nifty P/E ratio is at or above 22, it is considered overvalued, and when it is less than 14, it is considered undervalued. 

The Nifty 50 average P/E ratio is currently between 20 and 25, so a higher PE ratio above that may be considered overvalued, while a lower PE ratio may be seen as a better time to invest. As per NSE records whenever the Nifty 50 has a lower PE ratio then it has given better returns compared to when it has higher PE.

Going by the data of the last 30 years, it is observed that investors made money over the three-year period whenever the Nifty PE ratio was around 15-16. Conversely, it was a good time to sell when this figure exceeded 22 as returns turned negative over the next three years. In the last 20 years, Nifty PE ratio reached an all-time high of 40.43 on 20 February 2021. 

The tables below show the absolute return on investment in Nifty 50 companies for various PE ratios.

Nifty PE Ratio vs Nifty Index Value 

Investment decisions should not be based on the Nifty index value alone. The index at 17500 at a PE ratio of 20 is more attractive than the index at 15000 with a PE ratio of 30.

Mean reversion is pretty real in case of indices and it has a close connection with PE ratio. From the chart above, it can be observed that the value of the Nifty index tends to increase subsequently whenever the Nifty 50 PE comes in the attractive zone. Conversely, index has shown tendency to correct whenever the Nifty PE crossed 25.

It is important to note that these are general observations and play out over long months and years. As such, there may be a period of non-conformance to these guidelines. As an example, investors still made money when the index PE ratio crossed 25 in 2020 and went on to hit a high of 40 in 2021 before earnings improvement brought down the PE ratio to more reasonable levels.

A key point to remember is that Nifty 50 average PE has been rising over the years so very old figures may not be the best reference points.

The table below summarizes the value investing rationale for Nifty PE. 

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Key Points About Nifty PE Ratio Chart 

#1 Standalone in place of Consolidated 

Over the last decade or so, many Indian companies have made large overseas acquisitions that now contribute significantly to their operations and profits. All companies in Nifty 50 are doing acquisitions and mergers. But Nifty published price-earnings ratio is still based on standalone earnings rather than consolidated earnings. Now with more companies expanding and doing acquisitions, consolidated EPS makes more sense as consolidated earnings differ significantly from standalone earnings. 

#2 Uneven Distribution of Nifty PE ratio across sectors 

Nifty 50 is dominated by various sectors like FMCG, IT, Oil, Construction, Metals, Retail and Banks. Sectors like FMCG, IT and Banks dominate the movement of the price index. If these sectors go down, even cyclical sectors that are doing good like construction, metals and gas that have less dominance on Nifty PE would be understated though they have high EPS. An investor needs to look to Nifty 50 diligently in such cases. 

Conclusion

• Nifty 50 PE ratio of 18 indicates that investors are willing to pay 18 times the earnings of the basket of 50 Nifty constituent companies.
• Nifty is in the oversold zone when the Nifty PE ratio is below 14. 
• It’s taken as an overbought range when Nifty PE crosses 24. 
• Investors can expect the market to recover from oversold levels. The time required in this process can range from months to years. Similarly, the market doesn’t keep going up always and corrects from overbought levels.
• Smart investors take advantage of this greed and fear cycle and look for bargains when Nifty PE levels are in attractive zone.
• Over years, the average PE ratio of Nifty 50 has increased.

Before investing, however, one should always consider fundamental analysis and a combination of various valuation models. 

Happy Investing!