Valuation of the Nifty 50: Insights and Analysis

Composition of NIFTY 50:  

• The Nifty 50 index consists of stocks from 50 companies.
• Including notable ones like Reliance Industries Ltd, TCS, HDFC Bank, ICICI Bank, HUL, ITC, Infosys, SBI, HDFC, Bharti Airtel, Bajaj Finance, LIC India, Kotak Mahindra, L&T, Asian Paints, Axis Bank, Maruti Suzuki, and Sun Pharma, among others.
• Representing a diverse array of sectors such as conglomerates, financial services, information technology, energy, telecom, metals, infrastructure, and automotive, the index offers broad market exposure.

Context:

• The FY 2022-23 entailed a lot of uncertain events posing economic risks to almost all parts of the globe ranging from tightening interest rates to the Russia-Ukraine crisis.
• The global uncertainties posed its repercussions on Indian Equity markets largely where the S&P BSE Sensex appreciated by a meagre 0.72% and Nifty 50 appreciated by 1.37% for the FY 22-23.
• The top movers on the Nifty 50 Index were ITC, M&M, Britannia, NTPC and HUL. Whereas, the top losers were Bajaj FinServ, Tech Mahindra, Hindalco Industries, Divi’s Labs and Wipro.
• The valuation report aims to determine valuation in the above context
• The index has been valued using key factors such as dividends paid, buyback yield, earnings growth, equity risk premium and 10-year government bond yield that can be considered as an appropriate proxy for the risk-free rate.
• The valuation of the index is based on the methodology used by Dr. Aswath Damodaran (Dean of Valuation – NYU Stern) and his pronouncements on the Discounted Cash Flow approach. However, certain aspects of the methodology have been modified to suit the Indian capital markets and general macroeconomic scenario.
• The report is prepared using assumptions. Thus, the interpretation of results will be subjective and based on the user’s requirements. The report provides information about whether the NIFTY50 index is overvalued, undervalued or fairly valued which primarily are derived from cash flows (dividends and buyback) in the hands of investors/equity shareholders.
• The index’s valuation date shall be “26th July 2024” and all the data used for valuation are till 24th July 2024.

Pillars of Valuation:

• The valuation approach used to value the NIFTY 50 index is the Discounted Cash flow approach The pillars are: a) Free cash flow to equity (FCFE) b) Earnings growth c) Equity risk premium and d) Risk-free rate 

Free Cash flow to Equity shareholders:

• Free cash flow to equity is considered one of the key ingredients in the Discounted cash flow approach that describes the extent of shareholders’ rights over cash flows. Cash flow implies Free cash flow to equity shareholders (FCFE).
• However it is a tedious task to calculate FCFE for all the companies in the NIFTY 50 index and hence, a convenient and effective approach has been used where dividend payout and buyback are substituted for FCFE.
• The foregoing consideration is justified by the fact that, in the long run, all capital generated by a company will be distributed to its shareholders, either through buybacks or dividends or by liquidation if the company reaches maturity in its business sectors.
• The dividend yield has been sourced from the NSE website and buyback in emerging economies is miniscule and is not readily available.
• Hence buyback data has been sourced through Prof. Aswath Damodaran’s website which has been consolidated based on sectoral buybacks conducted.
• As buybacks do not contribute a big chunk of Cash flows, using the sectoral Buyback yield doesn’t cause major fluctuations in the valuation results

Earnings Growth:

• Earnings of NIFTY 50 companies are a function of index EPS and index price.
• Earnings are calculated using the P/E ratio formula where earnings are obtained by dividing the index’s P/E by the index’s price.
• The NIFTY 50 P/E ratio and corresponding price levels are sourced from the NSE website and then earnings are obtained.
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• The data taken from the NSE website provides daily data on prices as well as the P/E ratio. The yearly average P/E range and the yearly average price have been considered for the sake of convenience and ease.
• EPS CAGR for 10Y, 7Y, 5Y and 3Y has been calculated and an average of those has been considered respectively for final growth figures.
• However, there has been no significant difference in the growth rates between the above-mentioned time frames. The same has been depicted in the table beside.

 

Market Risk Premium

• Market risk premium (or equity risk premium) can be considered the rate of return that an investor expects over and above the risk-free rate for investing in a particular market or economy.
• It is a country-specific risk/market-specific risk.
• When the market risk premium is higher, investors are likely to take a conservative approach, playing the defensive and expecting average returns rather than higher ones.
• It also implies that the investors are willing to pay lower prices despite the constant cash flows.
• The data for market risk premium for valuation has been sourced through the Market Premia website.
• For our Valuation, we have considered the latest Market Risk Premium to account for the latest developments in Indian Equity markets.

Valuation

 

End note

I would like to thank the readers for their time dedicated to reading the report. Feedback is always welcome. Please feel free to get in touch at mailboxakash2@gmail.com for any questions and/or feedback

Acknowledgements

Report Prepared by – Akash Pandey

Note: This is Just for an academic project of Index Valuation on NIFTY 50, not any recommendation.

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