How fund houses adapted to market valuation change
Are the markets cheaper now? A popular market gauge used by analysts and investors suddenly showed that Indian markets have been trading at attractive valuations since September-end. Price-to-book (P/B) ratio of the benchmark Nifty 50 index, a metric used by many to judge the relative attractiveness of the markets, dropped to 3.45 on 29 September from 4.31 the previous day. The lower the ratio, the better it is—implying that the value of stocks is comparatively cheaper and ripe for investments.
It is now hovering around at 3.76. But wait before you click the buy button. This correction happened due to a technical reason.
However, the underlying fundamental and macroeconomics remains the same. The sudden correction happened due to a change in how the P/B ratio was calculated by the National Stock Exchange (NSE). The exchange cum index provider decided to replace the denominator with consolidated book value replacing the earlier method of using stand-alone book value.
The P/B ratio is obtained by dividing the current price of the share by its book value. Earlier, companies weren’t required to file consolidated earnings in their quarterly financial statements and, as a result, stand-alone book value was used to derive the ratio. But, over time, since the market regulator sought quarterly consolidated statements, NSE also changed its price-to-book (P/B) calculation methodology to incorporate this change.
To be sure, another popular valuation ratio, price-to-earnings (P/E), underwent a similar change in 2021. The Nifty 50 P/E ratio opened 18% cheaper on the day the change took place. This happened as the majority of the large companies have better earnings on a consolidated basis and, hence, the denominator was larger to pull
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