Index restructuring explained ~ Shareholder Awareness Program

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Index restructuring explained

 

Index restructuring explained




Nifty 50 index restructuring



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



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 23rd 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 31st, 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 25th 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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