Index restructuring explained ~ Shareholder Awareness Program

Index restructuring explained

Article published as on Tuesday, 24^th August, 2021 at 7:00 a.m.

Nifty 50 forward EPS
Index restructuring
Table on inclusion and exclusion from Nifty 50.
To conclude …
UPDATE:

Nifty 50 forward EPS

I am writing this article because nifty has been surging and there have been many reports where views/opinions/estimates/predictions are shared justifying the rally, and how Nifty EPS would increase in a significant way for FY22, FY23 and there onwards...

(Link to article, current Nifty EPS at Rs 654.15)

"In my opinion" the actual nifty 50 EPS would be much lower than anticipated because of the restructuring which happens every 6 months

Index restructuring

Nifty 50, nifty next 50, nifty 500 and for all other index restructuring happens every 6 months.

Changes come into effect on the first trading day after March and September F&O expiry every year.

How is it decided which stocks are going to enter and exit nifty?

Broadly the following criteria is used in the selection,

Stock whose free float market capitalisation has reduced have higher probability of exiting nifty.

And stocks whose market capitalisation free float market capitalisation has increased significantly are likely to enter into nifty.

The free float of the new stock shall be at least 1.5 times the lowest free float of the nifty stock.

There are other conditions as well, there is a detailed procedure outlined here is this link

(Link to index methodology)

Let’s look at restructuring that have happened since March 2018 till March 2021

Which constituents were removed and which were included.

Table on inclusion and exclusion from Nifty 50.

	Exclusions	current P/E ratio	inclusions	current P/E ratio
March, 2018
	Ambuja Cements ltd	33.44	Bajaj Finserv Ltd	1337.69
	Aurobindo Pharma Ltd	15.18	Grasim Industries Ltd	58.06
	Bosch Ltd	46.77	Titan Company Ltd	137.88
September, 2018
	Lupin	27.35	JSW steel	11.9
March, 2019
	HindPetro(HPCL)	3.63	Britannia industries Ltd	54.88
September,2019
	Indiabulls housing Finance Ltd	9.59	Nestle India ltd	85.26
March,2020
	Yes bank	N/A	Shree Cements Ltd	36.42
September,2020
	Bharti Infratel Ltd	15.01	Divis Laboratories Ltd	63.54
	Zee entertainment Enterprises Ltd	11.78	SBI life insurance Company Ltd.	88.16
March, 2021
	GAIL	10.11	Tata Consumer products Ltd	113.08

As we can see in last 3 years most of the stocks having Higher P/E ratio have entered nifty and mostly stocks with lower P/E ratio have exited the nifty.

(In the upcoming restructuring of 31st September IOC, Coal India are proposed to exit nifty and InfoEdge or Dmart are likely to enter into the nifty)

The exact details and information will be known for sure by a public notice at least 7 days before the day of restructuring.

(link to view restructuring notices)

(P/E based on closing prices as on 23^rd August, 2021)

To conclude …

The point is, we have companies from HDFC group, Bajaj group which have consistent growth in profits, but this performance is countered by changing constituents of index, where high P/E stock enter nifty, their impact is such that no significant growth in Nifty EPS is seen.

Also another point I want to discuss is that people judge Nifty as undervalued and overvalued based on the P/E ratio.

For example

P/E range of 12-15 was considered as being undervalued

And anything above P/E of 28 was considered overvalued

But we can see that Nifty has been trading above this level consistently now, and still its price level is increasing.

(After March 31^st, 2021 a change was made, that now consolidated earnings will be considered instead of standalone earnings, due to this Nifty EPS was boosted and P/E ratio declined)

Few years ago (say 2010 for example) nifty had stock which traded at cheaper P/E valuation, and today nifty consists of stock that trade at Higher P/E valuation.

So the same logic of undervaluation and overvaluation based on P/E range won’t be suitable and applicable in today’s scenario.

And the current Nifty EPS is Rs 653, so at the level of 16,500 the P/E Works out to be 25.

So the point highlighted in the article above are

1) Due to change in index stocks nifty EPS is not likely to go increase significantly as some of the analyst predict.

2) Valuing nifty based on previously followed P/E ranges won’t work anymore, as the fundamental composition of the index has itself changed over the years.

UPDATE:

In the most recent circular there are no changes in the Nifty 50 index, but there are several changes for the other nifty indices, the next changes will be made on 25^th March 2022.

Also in August it was proposed to include the REIT’s and InVIT’s in the index, but for the time being this decision is kept on hold.

In Hang sang Index, index of Hong Kong, the REIT’s and InVIT’s are already present.

India will also move toward inclusion of REIT’s and InVIT’s in its index. But first we need more such instruments and also a higher liquidity.

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