The recent rejig announcement by index managers of the Nifty50 has created a buzz among experts, as the entrance of Zomato and Jio Financial Services into the benchmark from March 28 is expected to expand the index’s valuation by 2.5 per cent.
Zomato, soon to be known as Eternal, and Reliance Industries’ delisted non-banking financial arm, Jio Financial Services Ltd, will replace Bharat Petroleum Corporation Ltd and FMCG major Britannia Industries in the Nifty 50 index.
BPCL and Britannia Industries with trailing price-to-earnings (P/E) ratio of 8 times and about 57x, respectively, will be replaced by Zomato and Jio Financial Services with trailing P/E of about 320x and 96x, respectively, by end of March 2025 within the Nifty 50 index. Due to this shift Nifty 50 P/E could inflate (on a trailing basis) from 22.1x to 22.6x, said an estimate by ICICI Securities.
Experts pointed out that companies without a business (Jio Finance) were being added to Nifty, while established companies like BPCL and Britannia were being discarded. High PE stocks will replace low PE stocks. “Something is wrong with this system They are making us buy low quality stock and sell fundamentally strong stocks,” said Rajiv Mehta in X post.
The criticism, however, seems slightly harsh.
Exchanges (both BSE and NSE) revamp their index constituents on a semi-annual basis based on set criteria, mainly market capitalisation. The Nifty50 is computed using a free float-adjusted (excluding promoter holding), market capitalisation weighted methodology, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. Earlier, computation used to be on full m-cap base
High liquidity
For a stock to qualify for possible inclusion into the Nifty50, it should have traded at an average impact cost of 0.50 per cent or less during the last six months for 90 per cent of the observations, for the basket size of ₹10 crore. That means, the stock must be highly liquid. Besides, companies must trade in F&O segment and have at least three months of trading history.
So, the entry of a stock is purely momentum-based depending upon the pre-determined quantitative model (quant) set up by the exchange.
As an index investor, should one really worry if ‘pricey’ Zomato and Jio Financial enter Nifty50? The weightage of these two entries will be less than 1.5 per cent in the Nifty50 which means they will have little sway in the movement of the benchmark. Top 5 stocks (Reliance, TCS, HDFC Bank, Bharti Airtel and Infosys) command 33 per cent of the weightage of Nifty and top 10 about 45 per cent.
Healthy CAGR
In the last 20 years, Nifty50 has produced a healthy CAGR of nearly 13 per cent. This period saw entry and exit of several wealth destroyers such as ADAG stocks, JP Associates, Unitech, and so on. However, one cannot rule out immediate volatility in the stock around the inclusion and exclusion dates as index funds tracking Nifty50 need to adjust them.
So, investors holding for a longer period through these passive vehicles need not worry. For others, there are always other options which they can consider based on their risk profile.
However, there is no doubt inclusion and exclusion criteria need to evolve according to market dynamics. As market veteran Shyam Sekhar suggested setting a minimum profit criteria for inclusion in the Sensex and Nifty50 may be considered down the line by index management.
