What does bond equity earnings yield ratio tell about Indian equity valuation?

Another valuation parameter, the bond equity earnings yield ratio (BEER) paints a similar picture. (Photo: iStock)

Mumbai: The past few months have been a roller-coaster ride for Indian equity investors. A combination of unfavourable domestic and global cues continue to dampen sentiment on the Dalal Street. In this week as well, key Indian benchmark indices the Nifty and the Sensex lost more than 2% percent each.

Consequently, valuation of Indian equities has come-off from its recent peak following the ongoing market correction. Currently, the MSCI India index is trading at a one-year forward price-to-earnings (PE) multiple of 17 times moderating from the high of 19 times.

Another valuation parameter, the bond equity earnings yield ratio (BEER) paints a similar picture. An analysis by domestic brokerage house Antique Stock Broking Ltd showed that at 1.1 times, BEER for the Nifty50 has slipped to similar levels seen during demonetisation and taper tantrum of 2012-13.

This ratio compares 10-year treasury bond yield to the earning yield of the stocks or stock index – in this case the Nifty. Earning yield is the reverse of the PE ratio. Theoretically, if the reading is at 1, it means that both equity and bond markets are fairly valued. A reading greater than 1 would mean that the equity market is overvalued, while below 1 means that equity market is undervalued.

However, as the alongside chart shows, although the ratio is a little above 1, the reading has been heading southward. At 1.1 times BEER is much lower than its historical average of 1.5 times.

As per the broking firm, since the Reserve Bank of India (RBI), akin to global central banks, is expected to further cut interest rates to boost economic recovery, valuations of Indian equities are unlikely to see a further de-rating.

“We believe there is a strong possibility of another 50 basis points repo rate cut by RBI given benign inflation, weak economic growth, fiscal consolidation and unchanged overall government borrowing along with an option of borrowing overseas through foreign sovereign bond. In the backdrop of easing risk free rate, we do not foresee further de-rating in Indian equities,” it said in a report on 29 July. One basis point is one hundredth of a percentage point.

That said, it cautions of some risks to valuations emerging from corporate earnings downgrade.

Meanwhile, the report further added that sectors which are looking attractive from BEER perspective are auto, pharmaceuticals, energy and capital goods. Also, large caps are looking more attractive as compared to mid-caps.

[“source=livemint”]