The Indian stock markets have generated significant wealth for investors over the past 3-4 years. The Nifty50 index has seen a return of 48.5 per cent over this period. Similarly, the Nifty smallcap 100 and Nifty midcap 150 indices have shown impressive returns of 76.6 per cent and 96.8 per cent respectively during the same timeframe. However, some well-known stocks have underperformed the index. The primary reason for this underperformance is often attributed to their high valuation.
To begin with, let's look at the Price to Earnings (P/E) ratio, which is a key valuation metric. This ratio provides insight into how much investors are paying for each dollar of a company's earnings, with higher ratios indicating a more expensive stock. Generally, stocks with a P/E ratio below 15 are considered value stocks, those between 15 and 25 are seen as fairly valued, and those above 25 are deemed expensive. Now, let's examine the stocks in the Nifty 500 index that have significantly fallen short of the index's performance over the last three years.
Out of around 500 stocks in Nifty500 index, about 25 have either seen no return or have returned very little. Prominent examples include Bata, Asian Paints, Metropolis, Star Health, Mphasis, SBI Cards, and Jubilant Foodworks, all of which had a P/E ratio above 25 in September 2021. This data suggests that investing in high P/E stocks can be a risky move, as these stocks often lag behind the overall market.
While the P/E ratio shouldn't be the sole consideration for investment, it's undeniably a crucial one. Investors should also look at other financial ratios such as Return on Equity (ROE), Return on Capital Employed (RoCE), and Debt to Equity (D/E) ratio in conjunction with the P/E ratio. Stocks that show consistent profit growth, a healthy ROE, low debt, and a reasonable P/E ratio are more
likely to generate above-average returns in the stock market.
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