On 31st March 2021, the NIFTY 50 Index PE decreased by around 18% overnight, without any significant market correction. How can it even happen?
The PE ratio for a particular share is the ratio of the Price of a share/Earnings per share. A higher PE ratio indicates overvalued share.
For example: A PE ratio of 30 indicates that for each rupee the company earns, investors are ready to pay 30 Rs.
NIFTY 50 P/E Ratio = (Total Free Float Market Capitalization of all NIFTY 50 Companies) / (Total Free Float Profit After Tax of NIFTY 50 Companies for the Last 4 Quarters)
The PE ratio for NIFTY 50 hit its all-time of above 40 in February 2021 and is on the decline since then.
The reason behind the fall is that on 24th February 2021, the National Stock Exchange (NSE) issued a press release that changed the formula for calculating the NIFTY 50 PE ratio.
Under the new system, the NIFTY 50 P/E Ratio is calculated based on the “consolidated” earnings of the NIFTY 50 companies instead of the “standalone” earnings numbers that were used earlier.
Consolidated numbers refer to the aggregate numbers reported by the firm’s entire business, including its subsidiaries.
This increased the denominator in the formula, leading to an 18% fall in the NIFTY PE ratio.
This change was made to provide a more realistic picture of stock market valuations, but the change now makes it difficult to compare the current PE ratio with that of the past years.
Satpal is an electrical engineer and a finance enthusiast. Nothing excites him more than reading books. Business, finance, economy? You have his attention. His mission is to spread financial literacy.