ICICI Securities say that the Nifty PE is shifting orbits. Current Nifty PE of 32.8x (based on FY20 EPS) and Trailing Twelve Months (TTM) PE of 38.5x has been off late a central point of argument among investors with relation to whether the broader markets are highly euphoric and run ahead of fundamentals.

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In ICICI Securities view, comparing PE multiples in isolation will not spell out the correct direction or assessment as to whether Nifty multiples are stretched or undervalued. For instance, looking at just TTM PE of 38.5x will definitely make one say about overvaluations but on the contrary this number does not give the correct picture as the TTM EPS so applied includes performance of Q1 FY21 and Q2FY21 wherein earnings of corporate India were completely washed out thereby deflating the true earnings. Secondly, markets are forward looking which tries to discount the future earnings potential of companies.

ICICI Securities try to dissect why TTM PE and forward PE of Nifty will shift to higher orbits based on the following:

Nifty constituents have undergone major change in the past decade and hence current and forward PE multiples have shifted to higher orbit. The weights of capital efficient sectors such as FMCG, Financials (private banks), IT and Pharma have increased from 29% in March 2009 to 70% in December 2020. Earnings visibility and consistency is preferred by markets and hence capital efficient sectors like FMCG,

Financials, IT and Pharma, which command higher PE multiples, have been gaining higher weightages in the Nifty.

Better performing business segments within existing companies is not captured by current PE multiples. Business models like L&T, SBI etc. have multiple business lines and hence SoTP (Sum of the parts) based valuations of these companies are not captured by the PE ratio alone. Bottom up P/E construct on expected performances signals shift in forward PE multiples of Nifty

Hence, in order to arrive at a fair value on the bottom up basis, ICICI Securities take a 10- 15% discount to their weighted average PE of 26.2x in order to account for future earnings downgrades and any other unforeseen macro risks which might risk earnings to come at a target PE range of 22x-23.6x. Consequently, ICICI Securities arrive at a fair value of 16300 on Nifty over a 12-18 month period (22x FY23E EPS).