Depending on the economy, equity prices fluctuate as does the earnings growth upon which P-E multiple valuations are based. But the law of averages holds good in the long run. Over a period of years, earnings growth averages out and so do P-E multiples. We applied the following methodology to make projections about likely Nifty levels in January 2020. While such an exercise will never yield pinpoint accuracy, it will offer useful directional trends.
Methodology: The Nifty is a weighted average of the 50 largest listed businesses in India. The NSE computes the P-E ratio on a daily basis. Averaging out daily prices and P-E ratios of the Nifty from January 1999 to November 2009, the average P-E over almost 11 years, is about 17.8. The P-E on November 27 when we closed our calculations was about 22 and the index closed at 4,941 on that day.
At the bottom of the worst bear markets, such as in May 2003 and October 2008, the P-E ratio hit lows of around 10.7. At the peak of big bull markets, such as February 2000 and January 2008, the P-E topped out at around 28.5.
We assumed that the high, low and average P-E of the Nifty will remain at about the same levels for the next 10 years. We also examined the weighted earnings per share (EPS) of the Nifty, as computed by the NSE over this entire period, which encompassed several booms and busts.
In January 1999, the EPS was Rs 76.66 and it was Rs 224.9 by November 2009 (the NSE uses the last four quarters, ending September 2009 in this case). The CAGR of the EPS over this period is around 10.5 per cent. We assumed that this EPS growth rate could be maintained for the next 10 years.
After that, it's simple. If the current 2009 P-E of Rs 224.9 increases at a CAGR of 10.5 per cent until January 2010, that means it will be around Rs 618, after a total increase of about 175 per cent.
Predictions: So, we can now make maximum, minimum and average projections over this period and, indeed, for every one of the next 10 years.
If the average P-E of 17.8 is maintained, the Nifty will be at around 10,993 points by January 2020, If the high P-E of 28.5 is reached (because it's a bull market), the index could reach the dizzy heights of 17,604.
If the low P-E of 10.7 is hit (because it's a bear market), the Nifty will trade at about 6,609.