Nifty at 10000 in a year? Before the next budget? Pretty sure most of you must have seen such headlines somewhere. Here is a layman's attempt at trying to figure out if these projections make any sense.
Nifty vs. EPS YoY Growth Rate
First let us look at the way in which Nifty earnings per share (EPS) has grown year on year (YoY). To calculate this, first the EPS is computed (closing price divided by index PE) and then the growth rate is rolled over 1 year intervals.
Notice that the EPS growth rate (right axis) has been quite range bound in the last 5 years. Looking at past growth rates during rallies, it seems to me that the rate at which Nifty has risen in the past 12 months is not as rapid as one would suggest. The rise is a sight for sore eyes, but one cannot trust sore eyes to make sound judgement.
Nifty EPS vs. Nifty PE
The nifty EPS (left axis) has pretty much increased at a steady pace of about 12% per year since Sep. 2002, barring the period during the 2008 crash and recovery. More on this here: State of the Markets – April 2014
So I think one can safely project it for the next 12 months, assuming the same rate of growth (red line).
The EPS on Sep. 16th 2014 is ~ 376.
Projected EPS on Sep. 16th 2015 is ~ 397. Let us make it an even 400.
This corresponds to an EPS growth rate of about 6%.
This is perhaps a little too conservative estimate, but let us run with it.
Now if the Nifty touches 10000 on 16th Sep. 2015 for the first time, the PE corresponding to an EPS of 400, will be 25.
Meaning: close to what experts would call, "extremely high valuations".
Therefore, if the Nifty hits 10000 in the next 12 months with an annual EPS growth rate of less than 10%, the PE will become dangerously high. Meaning the so called 'bull run' will sooner or later come to crashing halt.
If the Nifty has to breach 10000, and stay there for a decent amount of time, the PE will have to be much lesser than 25.
If we assume the PE in a year to be about 22 with Nifty at 10000, the EPS has to be ~ 450.
This means that the EPS has to grow by 20% from what it is today (16th Sep.).
Since the EPS has grown only by 8% in the last year, I am not too optimistic that there would be such a sudden surge in growth.
The current PE is ~ 21 (10Y average ~ 18.9). So even if the Nifty is at 10000, the PE is likely to be much higher than 22 as assumed above.
Let us hope/pray that I am proved wrong and that the Nifty comfortably breaches 10000 in a year and heads further northward 🙂