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Nifty P/E Ratio – Meaning, Calculation & Importance

3 Mins 24 Sep 2022 0 COMMENT 7 LIKES

The price-to-earnings ratio of a company is a metric that compares the market price of a stock to its earnings per share. It is also called the earnings multiple or the price multiple. Essentially, the P/E ratio of a company tells us how much money an investor in the market is willing to pay for one rupee of the company’s earnings. Calculating the P/E ratio of a company is simple. You need to divide the company’s current market price by its Earnings per share (EPS).

Did you know that you can calculate the P/E ratio of the Nifty 50 index as well? It is useful to understand how the index is positioned whether it is overvalued or undervalued.

What is Nifty 50 Price-to-Earnings Ratio?

The Nifty 50 P/E ratio is a metric that tells you how the index is valued. Historically, the Nifty 50 P/E ratio has averaged around 20. Any value above 25 indicates that the index is costly. It may be best to book profits and enter again when the market falls in such a situation.

When the index goes above 25, the market may be headed for a correction. For instance, before the 2008 market crash, the P/E ratio of Nifty 50 was around 28. From there, it took a steep crash. Knowing when to exit the market using the P/E ratio could be a good strategy for an intelligent investor.

If the P/E ratio of Nifty 50 is below 15, the index is undervalued. You can expect the stocks in the index to bounce back shortly. This may be a good time to buy shares in the index and book profit later. However, it doesn’t mean it will crash or bounce immediately on reaching the threshold level. So Nifty may also continue to trade at a lower or higher P/E ratio for an extended period. Besides, threshold levels like 25 or 15 will not always hold good; the market may also trade at a higher and lower P/E ratio.

How to Calculate the Nifty 50 P/E Ratio?

According to market capitalization, the top 50 Indian companies make up the Nifty 50 index. When calculating the P/E of an individual company, you can divide the company’s market price by its EPS.

To calculate the P/E ratio of the Nifty 50 index, you need to take the sum of the market capitalization of all 50 companies and divide it by the sum of their profit after tax. This will give you the P/E ratio of the index. As mentioned before, the index is stable as long as the P/E ratio of Nifty 50 is within the range. If the ratio moves up or down, you can change your investment strategy according to it, often with the assistance of a stock trading app.

Important Factors Related to Nifty PE

Below are three important factors you should know about Nifty P/E:

Standalone VS Consolidated:

Up until March 2021, the NSE published a standalone P/E for Nifty. However, starting in April 2021, they switched to consolidated earnings to calculate the Nifty P/E ratio.
This means one cannot directly compare the past Nifty P/E ratio to the consolidated Nifty P/E ratio.
Therefore, any analysis drawn about the relationship between the historical returns to the prevailing P/E ratio cannot be applied directly to the current Nifty P/E ratio.

Nifty P/E Depends On Price And Earnings

The value of the Nifty P/E is highly dependent on the movement of the price of Nifty and the earnings of the companies in the index.
This means that the ratio could potentially move up or down even if Nifty remains unchanged, depending on the increase or decrease in earnings.
Additionally, even if the Nifty rises, you might see a fall in the P/E ratio because the earnings are growing faster than the rise of the Nifty.

Always Use Other Indicators

The P/E ratio is just one of the metrics available to traders and investors. It is always better to use two or more metrics to determine whether the market is overbought or oversold.

Conclusion

The Nifty 50 P/E ratio is a metric used to understand the value of the Nifty 50 index. It is similar to computing the P/E ratio of a company, but instead of individual companies, it tells the health of the entire index. You can also compare the P/E ratio of individual companies against the Nifty 50 P/E ratio to understand how a company is performing compared to its index constituents.

FAQs About Nifty P/E Ratio

1. What is a good PE ratio for Nifty?

A good P/E ratio for Nifty, or, for that matter, any index, can vary depending on various factors. Historically, a P/E ratio between 15 to 20 is often considered reasonable for the index. However, it is wise to assess all other aspects and market conditions.

2. What is the PE ratio in options?

In options trading, the P/E ratio is not directly applicable as they ideally do not have earnings like in stock trading. Instead, options traders often use metrics such as implied volatility, time decay, and the option's intrinsic and extrinsic value.

3. Is the 7-PE ratio good?

A P/E ratio of 7 indicates that the stock is undervalued. However, it is also essential to consider other technical and fundamental factors.

4. Is a negative PE ratio good?

In most cases, a negative P/E ratio is not considered good as it suggests that the company is making negative earnings and is not generating profits. However, there are exceptions where the P/E ratio might not fully capture the potential such as when companies are in their high-growth phases or when they are reinvesting heavily into their businesses.

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