Nifty, at its cheapest, traded at a price-to-book value of 2.1 times in May 2003.
Indian indices have fallen over 30 percent over the past month, spooked by the alarming spread of the novel coronavirus both globally and locally, and its resultant economic impact.
Stocks by their very nature tend to be volatile and the Indian market has seen similar – or worse – crashes in the past, though the triggers were always different.
If one has to think of parallels to the ongoing market rout, most notably, the crashes of 1992 (the Harshad Mehta scandal), 2000 (dotcom bust) and 2008 (global financial crisis) came to mind.
But if one were to use history as a guide, how bad can a crash get? What are the levels, from a valuation perspective, at which all the bad news is priced into stocks?
A common valuation metric, the price-to-book-value says the Nifty, at its cheapest has traded at a price-to-book value of 2.1 times, in May 2003.
With the Nifty currently trading at 2.25 times, this would imply that the index is not too far away from its bottom.
Assuming a 10 percent fall from current levels would bring the Nifty to 7,900 levels.
Another metric to consider is the market-cap-to-GDP ratio, often prescribed by Warren Buffett as the parameter with which to evaluate stocks.
In 2008, the market bottomed out at a mcap-to-GDP ratio of 53 percent.
With India’s FY20 GDP expected to be at Rs 200 lakh crore, and the mcap of Indian stocks currently at Rs 116 lakh crore, the ratio stands at 58 percent.
Were the market to bottom out at mcap-to-GDP ratio of 50 percent, it would mean a correction of another 15 percent from current levels, or a Nifty of 7,200.
Finally, the most common metric that is used to judge stock valuations is the price-to-earnings ratio. It is the multiple of the price investors are willing to pay for a business times its annual profit. (So if a company with a Rs 100 crore profit as valued at Rs 1,000 crore, the P/E ratio comes to 10.)
On aggregate, the large companies in the benchmark indices such as the Sensex or Nifty have been valued at a P/E ratio of anywhere between 12 and 30, depending on the optimism (or pessimism) over future earnings. The average historical P/E ratio stands at around 16 times.
Before the market correction began, the Nifty was trading at a little over 12,000. With the Nifty companies expected to make earnings-per-share of Rs 540 this year (fiscal year 2019-20), the P/E ratio stood at a steep 22 times on a current-year basis.
This ratio has come down to a little over 15 times, slightly below the historical average.
Were the Nifty to come down to a P/E ratio of 12, it would translate to a level of 6,480, which could imply a correction of another 23 percent from current levels, or a total fall of about 50 percent from the peak.
Interestingly, 6,400 is also about the level at which the Nifty peaked out before the 2008 crash and after a rebound in 2010, and is considered sacrosanct by many technical analysts.
These analysts also say that before reaching 6,400, the Nifty could also find some support at 7,200 and 7,900 levels, the February and December 2016 lows.
The bottom line: both on a technical and fundamental basis, 7,900, 7,200 and 6,400 would be the levels where the Nifty could bottom out, if one uses history as a guide.Source: CNBC-TV18
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