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The Ship of Theseus Paradox - Nifty 2008 and Nifty 2016

I had recently made a 30 min presentation in the Flame Investment Lab - Alumni Meet at Flame Univesity - Pune this weekend.

The presentation talks about how Nifty and benchmark indices have changed in last 8 years as well as since the inception in 1996 and can the Nifty today be compared to the past.

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The Ship of Theseus Paradox - Nifty 2008 and Nifty 2016

  1. 1. The Ship of Theseus Paradox – Nifty 2008 and Nifty 2016 Nooresh Merani
  2. 2. The Free Float Market Cap Methodology • Free-float market capitalization takes into consideration only those shares issued by the company that are readily available for trading in the market. • It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course.
  3. 3. Example – State Bank of India • Market Price = 205 on 31st May 2016 • No of Shares = 7762777042 • Market Cap = 7762777042 * 205 = 159098 Cr • Promoter Shareholding = 60% roughly • Free Float Shareholding = 40% • Free Float Market Cap = Free Float % * Market Cap • = 40% of 159098 = 63639 • So the Free Float Market Cap of SBI is 63639 Cr and it has a weightage 2.13% in the Nifty Free Float 50 Index.
  4. 4. Example – Kotak Mahindra Bank • Market Price = 746.55 on 31st May 2016 • No of Shares = 1834382158 • Market Cap = 1834382158* 746.55= 136945 Cr • Promoter Shareholding = 40% • Free Float Shareholding = 60% • Free Float Market Cap = Free Float % * Market Cap • = 60% of 136945= 79438 • So the Free Float Market Cap of SBI is 79438Cr and it has a weightage 2.66% in the Nifty Free Float 50 Index.
  5. 5. Free Float Problem • So even though State Bank of India has a much higher market cap compared to Kotak Mahindra Bank the weightage in Nifty is lesser than it. • SBI is at 2.13% compared to 2.66% for Kotak Mahindra Bank.
  6. 6. Free Float Methodology Adoption • Sensex has been on a Free Float Methodology from September 2003 • Nifty shifted to Free Float Methodology from June 2009 • Majority of the Indices in the World are based on Free Float Methodology !! • Higher the Free Float – Higher the Liquidity – Lower the Impact Costs and lesser chances of Manipulation makes it ideal for Exchanges to have Free Float Index.
  7. 7. The Effects of Free Float Methodology in Indian Indices • Around the world the promoter holdings are low and the float is anywhere between 40-90% • In India till the time 75% the float was between 10-60% • Financials get a higher weightage as the free float is higher as promoter shareholding is lower. • PSUs get a lower weightage in the Index as the promoter shareholding is high and free float is low. • The big concern in Bull Market is company diluting capital receive higher weightage to a company doing buybacks.
  8. 8. The Churn in Nifty & Sensex • Only 30-35% of the Index or roughly 1/3rd of the original constituents of Nifty ( 1996) and Sensex ( 1986 ) are still present in the Current Nifty. • Every 10 years the churn is almost 40-50%. • A lot of so called Blue Chip Companies coz of presence in Nifty/Sensex in a decade turn down to be obsolete and destroy shareholder wealth. • Apart from the churn the Weightage Shifts are also Huge. • Luckily Nifty has a Rule of 5 changes only in a year and that too twice a year only else the churn would be much more !! ( For example today bottom 5-6 stocks free float market cap is lesser than 5-8 names from Nifty next 50 index. )
  9. 9. The Ship of Theseus Paradox • The ship wherein Theseus and the youth of Athens returned from Crete had thirty oars, and was preserved by the Athenians down even to the time of Demetrius Phalereus, for they took away the old planks as they decayed, putting in new and stronger timber in their places, in so much that this ship became a standing example among the philosophers, for the logical question of things that grow; one side holding that the ship remained the same, and the other contending that it was not the same. • — Plutarch, Theseus[2]
  10. 10. Ship of Theseus Paradox - 1 – Nifty 50 Analyse India
  11. 11. Ship of Theseus Paradox - 2 – Nifty 50
  12. 12. Nifty – 2008 if you did not change the Planks/Stocks Analyse India Nifty on 31st Jan 2008 5137. 45 After many changes in Stocks Nifty on 29th June 2016 8204 Returns 59.70 % Nifty on 31st Jan 2008 5137. 45 Keeping same Stocks Nifty on 29th June 2016 7170 Returns 39.60 % But if you randomly bought Nifty 50 at various times in 2010/2011/2013 the returns would not differ by much But if you randomly bought Nifty 50 at various times in 2010/2011/2013 the returns would not differ by much
  13. 13. Nifty – New Planks in every Euphoria. Example 1999-2000 – IT & Media • Inclusions in The Euphoria of 1999-2000 • Infosys / NIIT got included in Nifty in October 1998 at a price of 20 and 120 and were at 400 and 500 by the peak March 2000. ( Adjusted prices) • Satyam inclusion in September 1999. HCL Infosystems and Zee Tele in May 2000. Digital Equipment India in Sept 2000. • Many other old economy stocks Bpcl, mrpl,thermax, Andhra valley power supply , GE Shipping etc got excluded. Analyse India Inclusion of IT stocks Increased closer to Y2K peak. Easy to say in Hindsight Inclusion of IT stocks Increased closer to Y2K peak. Easy to say in Hindsight
  14. 14. Nifty – New Planks in Euphoria. Example 2005-2007 • Suzlon/Siemens included in June 2006 • Reliance Communications in Sept 2006 • Reliance Petroleum/Sterlite Inds in April 2007 • Unitech included in October 2007 by that time it was a 500-800 BAGGER from 2004 prices. • Idea Cellular/Cairn included in December 2007 • DLF/Power Grid included in March 2008 • Tata Tea, IPCL,hpcl, mtnl, Glaxo, bajaj auto, Shipping Corporation etc were the companies removed. Inclusion of Real Estate Stock like Unitech just before peaking out. Easy to say in Hindsight  Inclusion of Real Estate Stock like Unitech just before peaking out. Easy to say in Hindsight 
  15. 15. Nifty – New Planks in 2016 • Aurobindo Pharma, Bosch, Eicher Motors included because of huge outperformance and major weeding out of old wealth destroyers like Reliance Infra, Jaiprakash Associates, Vedanta, cairn etc. • So no new sector becoming a major part of the Index because of outperformance. • More of a decaying planks or wealth destroyers weeded out. • No Euphoric sectoral moves leading the Market. Analyse India The churn today is more so because of the underperfor mance of many stocks then coz of new fresh Polished Planks  The churn today is more so because of the underperfor mance of many stocks then coz of new fresh Polished Planks 
  16. 16. Nifty the Ship of Theseus from 2008 to 2016 Analyse India 31st January 2008 31st May 2016 RELIANCE 12.15% INFY 8.36 ONGC 7.13% HDFCBANK 7.91 BHARTIARTL 5.49% ITC 6.62 NTPC 5.45% HDFC 6.55 SBIN 4.61% RELIANCE 5.3 ICICIBANK 4.29% ICICIBANK 4.77 RCOM 4.17% TCS 4.58 LT 3.59% LT 4.05 BHEL 3.40% TATAMOTORS 2.98 SAIL 2.99% AXISBANK 2.88 INFOSYSTCH 2.89% SUNPHARMA 2.77 TCS 2.88% KOTAKBANK 2.66 HDFC 2.71% SBIN 2.13 ITC 2.48% M&M 2.06 RPL 2.41% HINDUNILVR 2.03 UNITECH 2.10% MARUTI 1.85 WIPRO 2.08% INDUSINDBK 1.8 HDFCBANK 1.87% BHARTIARTL 1.55 TATASTEEL 1.82% ASIANPAINT 1.49 STER 1.78% HCLTECH 1.4 Only 10 survive in Top 20 Only 10 survive in Top 20 4 are no more part of Nifty 4 are no more part of Nifty Top 4 of 2016 = 29.4% Was only 10% in 2008 Top 4 of 2016 = 29.4% Was only 10% in 2008 RIL and RPL =14.56% in 2008 is now only 5.3% RIL and RPL =14.56% in 2008 is now only 5.3% RCOM at 7th no more part of Nifty. RCOM at 7th no more part of Nifty. Big Shift from 24- 25% being Oil and Gas to Financials at 30% Big Shift from 24- 25% being Oil and Gas to Financials at 30%
  17. 17. The Big Shift from Investment Linked Nifty to Financials Led Nifty Analyse India Investment Linked 23.97 Exports 23.44 Financials 30.29 Consumers & Disc 20.82 Nifty 2016Nifty 2016
  18. 18. How do Analysts/Market-Men Value Nifty • Generally most of the Strategy Reports talk of how Nifty is quoting at 20x Trailing earnings/ 16x forward earnings and how it is higher than the Average P-E Multiple of last 10 years etc !! • A recent report mentioned a target based on a possible multiple of 14x as that was the Index multiple in post 2008. • Most analysts compare current/forward P-E of Nifty to the Average/Mean/Peak/Bottom P-E of historical Nifty. Analyse India
  19. 19. The Valuation Problem with Nifty of 2016 • Today’s Nifty 50 is not even comparable to that 10 years back. Only 3 out of Top 10 in Nifty in 2007 are still there in the Top 10. Refer our note - Nifty 2016 is a very different animal from Nifty 2008 !! • So how can we really try to compare current valuations to previous averages when it was a totally different Nifty? It’s like comparing what P-E HDFC Bank deserves in comparison to SBI. (SBI had a weight of 4.61% in 2007 and now 2% compared to HDFC Bank from 1.87% weight to 7.5% today!! ) Analyse India
  20. 20. Shift towards Financials makes the P-E Multiple shift higher • 30% of Nifty is now Banks and Financials where parameter for Valuation is generally Price to Book and not P-E. • Lack of PSUs like ONGC/SBI/NTPC and capital intensive biz like Reliance which are generally at Low P-E. • Embedded Values in Financials in terms Insurance/Asset Management and Foreign Subsidiaries in Tata Motors etc keep P-E high in some stocks and then others like Asian Paints/ITC/HUL/Pharma tend to trade at higher P-E. Analyse India
  21. 21. Conclusions • Conclusion – Possibly The Base P-E or Average P-E is much higher for current Nifty !! • Low Debt Companies and Less Capital Intensive and less Investment Linked Companies in Nifty 50 make it an Index which does not Swing Wildly in Magnitude. • We would not see wild swings of 30% absolute downsides in corrections ( like in 2004/2006) or 60% downsides in Nifty in Bear Markets ( 1992/2000/2008) until we see New Planks i.e New stocks becoming part of the Index because of a huge outperformance. Analyse India
  22. 22. Nooresh Merani Cell: +91-9819225396
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