IN THE PAST THREE MONTHS, the S&P CNX Nifty has lost 700 points, or nearly 15% of its value, from this year’s peak in late February, leading to questions on whether it’s the best time to buy. However, in the past, the market has been even cheaper. In 2008, the National Stock Exchange (NSE) benchmark index bottomed out at a price/earnings multiple of 10.7, and in 2003 when the market reached a P/E multiple of 11. In comparison, the Nifty is around 16.5 times its trailing (last 12 months’) earnings based on its closing price on May 21, 2012. On this measure, the Nifty should fall by another 25% to 30% for the market to become a screaming buy.

But experts such as Devang Mehta, vice president and head, equity sales, Anand Rathi Securities, an investment bank, say such linear comparisons may not work any more because the index is now a different animal from the 2008 meltdown. “There is a possibility of the market falling a bit from the current level but then it has a tendency to rebound sharply from lows, catching investors by surprise,” says Mehta. In 2008, the Nifty was dominated by banks, capital goods, infrastructure, power, and oil and gas stocks. Reliance Industries was the most influential stock with a 12% weight. Now, Reliance has been pipped by ITC, a relatively more stable stock.

Raamdeo Agrawal, joint managing director and co-founder of Motilal Oswal Financial Services, says, “The thing about benchmark indices in India is that during a boom, bad companies enter the Nifty, and during a downturn, they are thrown out and replaced with good stocks.” By “bad companies”, Agrawal means those with poor balance sheets and unsustainable business models, while the “good stocks” are those with stable and predictable businesses backed by strong balance sheets.

This becomes clear with the recent replacements in the Nifty. In April this year, Asian Paints, a company with zero debt and a long history of year-on-year increases in earnings and dividends, replaced Reliance Communications, which is groaning under debt and shrinking profits. There have been similar substitutions in the recent past (see chart).

According to Agrawal, this reflects the market’s shift to safety and quality against a singular focus on growth in the past. The safe stocks in the consumer and pharma spaces now have a weight of 16% in the index against 6.3% in early 2008. Software companies, another haven of safety, account for a further 13% of the index. Safety, however, comes at a price, with stocks such as ITC, Hindustan Unilever, Sun Pharma, Cipla, Infosys, TCS, and Wipro always trading at a premium to the market. “Investors in the Nifty now have the option of better-quality companies than in the past and should not mind paying a premium,” says Agrawal.

Anand Kuchelan, vice president, research, Padmakshi Financial Services, echoes Agrawal. He says the recent changes have also reduced the potential of downside in the index’s earnings per share (EPS).

“No one expects companies forming the index to post losses or actually decline in profitability. At worst, there will be a slowdown in EPS, but this is already accounted for in the current valuations,” says Kuchelan. He says there is a lot of value in the market right now but liquidity is lacking. “Once that begins to flow in, there may be a sudden reversal in market sentiment.”

However, Ajay Bodke, head, investment strategy and advisory at financial services company Prabhudas Lilladher, feels too much is being read into the Nifty’s composition: “The change in the index’s composition is a continuous process, which reflects the evolution of the economy. This shouldn’t change the market outlook.” Bodke adds that the market may remain volatile until the underlying economic issues are sorted out.

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