Nifty’s Earnings Per Share has now risen to 348, derived from it’s P/E ratio of 17.59. This gives us an EPS growth of just 7.9% over the previous year, showing you a massive difference between valuations and reality.

Even if we assume that P/E is for the future and EPS growth is of the past, then if we offset the P/E chart one year back (that is, compare the P/E of 2013 with the actual growth we saw in 2014) we get a picture of stark differences: (We compare the “normalized” P/E versus EPS growth).

No, Watson, we did not have a P/E of 7 last year. In fact even if you look at 5 Year EPS growth (annualized) then the Nifty comes up terribly low:

Even today it’s at a 10% to 11% range with a max of 14% in 2009, **which is absolutely horrible considering we’ve given ourselves a P/E of more than 15 for all of the last five years.**

Valuation isn’t only about P/E but P/E plays a huge role. When earnings growth recovers, it could just be that the P/E goes back into the 10-12 range and thus, results in no change in the Nifty. A lot about equity markets is sentiment, and the graphs above tell you that **we have had high expectations of earnings growth, but substandard actual growth.**

*Related*

anishFebruary 23, 2014 at 11:11 PMHi Deepak,

the entire concept that on a normalized basis, fair value is when PEG = 1 is completely non-sensical! It becomes even more hilarious when you look at it from a short-term perspective such as one year. So if you assume that “G” is 7 and therefore fair “PE” should be 7, would you say that P/E should be 1 when G is 1? there are ofcourse many examples in various countries where G was 1 or even -ve in a specific year !!

I think this is a fundamental mis-conception. I think the book by Vitaily (http://www.amazon.in/Active-Value-Investing-Range-Bound-Markets/dp/0470053151) gives a good start on how you should value earnings to value!

regards

anish

Deepak ShenoyFebruary 24, 2014 at 1:26 AMAnish, I think it’s different in edge cases, but to have a consistently wide gap between P/E and actual earnings growth is crazy. Edge cases wise one can always justify things, but it is ludicrous that even 5 year EPS growth charts remain SUBSTANTIALLY below P/E’s normalized, for most if not all of the time.

The concept of PEGs of 1 is sound at the 10-25 ranges; there are other things that impact earnings and P/Es of course, most of which are expectation or holding asset value driven, but most of that are at stock levels and usually balance out at an index level. Will read that book if I get my hands on it, thanks :)

However what is important to note is that the anomaly is huge. It could also be that when we go nuts on the downside (i.e. give a P/E of five for an economy growing at 15%) we might just have to live with it…