The elevated price-earnings of the benchmark Nifty 50 may sustain in the near term given the favourable ratio between the 10-year government bond yield and the earnings yield of the index.
The ratio that measures relative attractiveness of equities over bonds is currently at 1.22 — in line with the 10-year average of 1.17.
The bond-earnings yield ratio, often called as BEER ratio, is calculated by dividing the benchmark 10-year bond yield and earning yield of the stock market or the benchmark index. India’s 10-year bond yield is currently at 6.58 per cent, while the earnings yield of the Nifty 50 is 5.4 per cent, which is the inverse of the price-earnings (P/E) multiple.
According to Axis Capital’s calculation, the BEER ratio is the lowest since 2013. If the ratio is high, the stock prices will likely fall and vice versa. Since the Nifty’s BEER ratio has been in line with long-term average, it will support current valuation.
The BEER ratio is easing due to the softness in the government bond yield after RBI’s operation twist, an exercise by the central bank to buy long-term bonds and sell short-term bonds to make the yield curve flattish. The bond yields have dropped nearly 30 basis points in the last one-and-a-half months.
The lower BEER ratio may lift the fair value of the constituents of the Nifty thanks to the lower cost of capital in the form of low interest rates in the economy thereby lifting P/Es. For instance, stocks of RILNSE -0.46 % and Asian Paints gained 41 per cent and 28 per cent, respectively, in one year, while earnings growth was over 9.6 per cent for each of them.
The Nifty 50’s one-year projected P/E is 18.5, which is at 22 per cent premium to the long-term average. Despite this, the index may continue to sustain the momentum going by the movement in bond market yields.
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Sources : Bloomberg
