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 March-April 2020
ISSN: 0193-4120 Page No. 18360 - 18368

Does Valuation Models Work well for Sensex stocks

in Indian Stock Market? – An Empirical Analysis
Nitha.K.P 1, Dr. S. Sivakumari 2, Dr Suraj E S 3
1. Research Scholar, Department of Computer science and Engineering, School of Engineering,Avinashilingam
Institute of Home scienc& Higher Education for Women.
2. Professor and Head, Department of Computer science and Engineering, School of EngineeringAvinashilingam
Institute of Home scienc& Higher Education for Women.
3. Associate Professor, Department of Management Studies, Naipunnya Business School, Pongam, Kerala..

Article Info
Volume 83
Page Number: 18360 - 18368
Publication Issue:
March - April 2020
Article History
ArticleReceived: 24 July 2019
Revised: 12 September 2019
Accepted: 15 February 2020
Publication: 30April 2020
Abstract: Investors from stock market using different valuation models to
predict the intrinsic value of stocks to earn reasonable returns using different
models. But most of the studies indicate that valuation models are unable to
predict the intrinsic value of stocks very accurately due to various reasons.
Accurate equity valuation will help the investors to choose the best equity
shares by way of using the best valuation model for investment purpose in
Indian Stock Market.This paper investigates the importance of three equity
valuation models in terms of valuation accuracy of Sensex stocks in Indian
Stock Market. This paper shows the predictive power and valuation accuracy of
P/E Model, P/B model and CAPM to know the significance and reliability of
the models for Sensex stocks in Indian Stock Market. This study selected a
sample of 30 companies which constitute the BSE sensitive index (Sensex).
There are high levels of valuation errors for stocks in India using P/E Model
and P/B Model. But the valuation accuracy of capital asset pricing model was at
high level and can be used for predicting the intrinsic value of Sensex stocks in
Indian Stock Market.
Keywords: Valuation model, Sensex Stocks, Intrinsic Value

I. INTRODUCTION in Indian stock market. This study also focused on

Valuation of equity shares is very important for
investors to earn return from stock market. There
are different equity models used for estimating the
intrinsic value of stocks. Valuation models will
give different intrinsic value due to difference in
the inputs used in the models. So it is very
important to know the fundamentals of the
company and the most influencing fundamental
variables of each valuation model influencing on
the value of Sensex stocks. This study will help
the investors to choose the best model out of P/E
Model, P/B Model and CAPM for Sensex stocks
testing the predictive power of the both of these
relative valuation models and CAPM which
explains the variation in the market price by the
variables of each model. Theoretically all models
are equivalent. Mean absolute Percentage Error is
the statistical tool used to measure the valuation
accuracy of both of these models for Sensex
stocks. Using another statistical tool, BIAS-
Signed Percentage Errors, which will help to
determine the undervalued and overvalued stocks
in Sensex? This study test and study the
correlation between the variables of these
valuation models with market price. So investors

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can identify the most significant accounting
variable influencing on the share price movement.
II. REVIEW OF LITERATURE
Firer (1994) studied the complicated relationship
between price earnings ratio and cost of equity
capital for several firms in US stock market and
found that P/E ratio was positively related to the
net present value of the firms’ growth
opportunities and negatively related to discount
rate which in turn positively related to risk.
Subramaniyam and Mohan Venkitachalam (1998)
found that past earnings were relevant for
valuation when earnings have transitory
component. Book value provided significant
incremental explanatory power while current and
past earnings provided only marginal explanatory
power for loss firms. Adams, Michael (2002)
studied on expanding the list of valuation metrics
for estimating the value of non-publicly traded
firms. The results provided strong support for
future research to identify a broader range of
explanatory financial variables to determine the
firm value for all non-publicly traded firms. Seiji
Oghishima (2002) found a significant positive
relation between stock prices and stable
ownership of firms. Mark Kamstra (2003) found
that fundamental models had more trouble in
explaining the price movements of the overall
market..
Javier (2004) studied that strategies based on Price
Earnings Risk Growth (PERG) ratios adjusted
with the growth and risk outperformed in the
market. It also found that PEG ratios improved
upon P/E ratios by adjusting with growth. John
Campell (2006) focused on dividend price and
price smoothed earnings ratio to predict stock
prices. It found that linear regressions of price
changes and total return on the valuation ratios
suggested substantial decline in real stock price. It
was also found that true relation between
valuation ratios and long horizon return was non-
linear in nature. KenthSkognovisk (2008) studied
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the importance of PE Ratio in relative valuation
and showed that relative P/E ratio valuation was
not be able to handle differences in the expected
book return or growth of owners' equity. Michael
Chrystal (2008) found that value of the company
was determined using the combination of
comparable company, comparable transaction and
discounted cash- flow methods. Ne CulaiTabara
(2008) presented the methodology of valuing
equity of a non-listed company with the purpose
of establishing share price for the first time on the
stock exchange market. The multiple selected was
the average of three values of arithmetical mean,
median and harmonic mean of price earnings ratio
which illustrated the best choice for determining
the value of stocks.
Mohammad Reza Tavakoli (2010) studied the
relationship between systematic risk and return in
three selected markets of Iran economy using
CAPM and found that negative relationship
existed between systematic risks with realized and
expected return of the currency market; negative
relationship between risk and expected return rate
in the stock market; and positive linkage between
these two variables in the real estate market. Kapil
Choudhary, Sakshi Choudhary (2010) examined
the CAPM for the Indian stock market using
monthly stock returns from 278 companies of
BSE 500 Index listed for the period of January
1996 to December 2009 and found that higher risk
was not with higher levels of return for stocks and
residual risk had no effect on the expected return
of portfolio. W. S. Nel (2011) investigated
academic consensus among chartered accountants
regarding the use of CAPM and revealed that both
academia and investment practitioners favoured
on calculating the cost of equity and disagreed
significantly with regard to the components of the
model.
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III. RESEARCH METHODOLOGY
Objectives of the study
1) To test and measure the predictive power and
valuation accuracy of P/E Model , P/B Model and
CAPM for Sensex stocks in India.
2) To know the significance and reliability of P/E
Model, P/ B Model and CAPM for Sensex stocks.
3) To suggest the appropriate valuation model for
valuing Sensex stocks in Indian Stock Market.
Sources of data
The study used secondary data. Secondary
sources include National Stock Exchange’s official
website (www.nseindia.com), Bombay Stock
Exchange’s official website (www.bseindia.com),
and databases like Centre for Monitoring Indian
Economy (CMIE) Prowess and annual report
library services like Ebsco Services. Secondary data
include financial variables and accounting
information such
asyearlybookvaluepershare,earningspershare,marke
tprice ofshare,beta, EPS Growth rate, Return on equity,
Risk free rate, etc.,ofeachstock and Sensex return of
Sensex. Total of 30 stocks, constituting Sensex
stocks are selected for the study.
The following three appropriate equity valuation models
for valuing bank stocks are identified for the study:
1. Price to Earnings Model (P/E Model)
Predicted P/E = β0 + β1BETA + β2 EPS g+ β3DPR
+εi
Intrinsic value =Predicted PE * EPS
2. Price to Book value Model (P/BModel)
Predicted P/B = β0+ β1BETA + β2 EPS g + β3
ROE + β4 DPR + εi
Intrinsic value = Predicted PB *BVPS
3. CAPM (Capital Asset Pricing Model)
Intrinsicvalue = Last year Market Price + [Last
year Market Price * Expected Return]
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Expected Return = R f + βeta(R m– R f)
Statistical Tools used for the study
a) Multiple regression is used to examine
the predictive power of P/E Model and P/B
Model for Sensex stocks in Indian Stock Market
Table - 1.1. List of Regression Models used in the
Study
Model Valuation Regression Model
No.
Models
1) Price to Earnings MP = β0 + β1 BETA
Model + β2 EPSg +β3 DPR
+ β4 EPS +εi
2) Price to Book value MP = β0 + β1 BETA
Model + β2 EPSg +β3 ROE
+β4 DPR + β5 BVPS
+εi
3) Capital Asset Pricing MP = β0 + β1 BETA
Model + β2 Rm+ β3 Rf + εi
b) MAPE- Valuation accuracy of each Sensex
stock is measured by calculating the mean absolute
percentage of error (MAPE) between the stock’s
calculated intrinsic values with actual market
price.
MAPE it= |(P’it– Pit)| / Pit x 100% where MAPE
it is the Mean Absolute Percentage Error for bank
c) BIAS- It is measured by calculating the signed
valuation errors (BIAS) between the calculated
intrinsic values with market price.
Bias it= (P’it– Pit) / Pit x 100% where bias it is
the signed percentage error for bank.
P’it = Market price, Pit= Intrinsic value.
d) Simple Regression Analysis- Simple
regression analysis is used for finding the
relationship between intrinsic value and market
price of P/E Model and P/B Model for Sensex
stocks in Indian Stock Market.
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Hypotheses Model, P/B Model and CAPM of Sensex stocks are

detailed below:
In line with the objectives, the study tested the
following major hypotheses besides a number of
working hypotheses:
H01: The independent variables are not explaining
the variation in dependent variable (market price)
in P/E model , P/B Model and CAPM for Sensex
stocks in India.
H02: There is no significant relationship between
intrinsic value and market price of P/E model, P/B
Model and CAPM for Sensex stocks in India.
Methodology
a) Identifying three valuation models- P/E
Model, P/B Model and CAPM for Sensex
stocks in the Indian context.
b) Determining the predictive power of these
equity valuation models for Sensex stocks in
Indian Stock Market.
c) Measuring the accuracy of three equity
valuation models using Mean Absolute
Percentage Errors (MAPE).
d) Identify the Undervalued and overvalued
Sensex stocks using BIAS( Signed
Valuation Errors) with appropriate valuation
models.

The study has followed a systematic procedure to

check the predictive power and accuracy of P/E
IV. ANALYSIS
Predictive Power of Equity Models (P/E Model, P/B Model and CAPM)
This section tests the predictive power of three equity valuation models P/E Model, P/B Model and CAPM
for Sensex stocks using multiple regression analysis.

Table – 1.2. Predictive Power of Price to Earnings Model

R Adjusted
R Std. Error of the Estimate Durbin-Watson
Square RSquare
.615a .379 .371 755.03 .577
Regression Coefficient
Std.
Unstandardized
Coefficients
Model Coefficient T Sig.
B Std. Error Beta
Constant 280.55 141.41 1.984 .048
EPS 12.49 .918 .626 13.602 .000*
EPSg -5.25 4.84 -.053 -1.085 .279
Beta -95.21 106.26 -.042 -.896 .371
DPR -.169 .565 -.013 -.299 .765
Predictors: (Constant),EPS, EPS Growth, Beta, DPR
b. Dependent variable: Market price Note: Results obtained by using SPSS 17.0
** Significant at 5% level of significance *Significant at 1% level of significance
H01a: Independent variables such as EPS, EPSg, Beta and DPR are not explaining the variations in
market price (dependent variable) in Price to Earnings Model

It shows regression results to test the predictive square value is 37.9% and adjusted R square value
power of P/E Model. In the model summary, R is 37.1%. It means 37.9% of variation in the market

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price (Dependent Variable) is explained by the c) not influenced by EPSg DPR and Beta.Thus, the
chosen independent variables. Market price is a) independent variable EPS explaining the variations
positively and significantly influenced by EPS; and in market price.

Table – 1.3
Predictive Power of Price to Book value Model
Adjusted R
R R Square Square Std. Error of the Estimate Durbin-Watson

.434a .189 .176 864.14 .472

Regression Coefficients
Unstandardized Std.
Model Coefficients Coefficients T Sig.
B Std. Error Beta
Constant 262.815 174.93 1.502 1.34
BVPS 1.542 .193 .416 7.992 .000*
EPS g 4.233 5.888 .043 .719 .473
BETA -154.23 129.81 -.068 -1.188 .236
DPR -.238 .670 -.018 -.355 .723
ROE 6.930 2.808 -.156 2.468 .014*
Predictors: (Constant),BVPS, EPS g, Beta, DPR,ROE
b. Dependent variable: Market price Note: Results obtained by using SPSS 17.0
** Significant at 5% level of significance * Significant at 1% level of significance
H01b: Independent variables such as BVPS, EPSg, Beta, DPR and ROE are not explaining the
variations in market price (dependent variable) in Price to Book value Model

It regression results to test the predictive power of

showstheshowsregressionresultstotestthepredictivep
owerof P/B Model. In the model summary, R
square value is 18.9% and adjusted R square value
is 17.6%. It means 18.9% of variation in the market
price (Dependent Variable) is explained by the
chosen independent variables.Market price is a)
positively and significantly influenced byBVPS; b)
Positively and significantly influenced by Return on
Equity. As the p-values for BVPS and ROE are less
than 0.01, Thus, the independent variables such as
BVPS and ROE are explaining the variations in
market price.
From P/E Model and P/B Model, it was found that
Earnings per Share (EPS), Book value Per Share
(BVPS), and Return on Equity are able to explain
the variation in market price significantly. So it was
proven that accounting variables still have influence
on the market price of shares.This table 1.4 shows
Published by: The Mattingley Publishing Co., Inc.
Capital Asset Pricing Model. In the model
summary, R square value is 00. 8% and adjusted
Rsquarevalueis
0%.Itmeansvariationinthemarketprice(Dependent
Variable) is not explained by the chosen
independent variables. Market price is not
influenced by Beta, Rm and Rf. Predictive power of
all these valuation models is at very low level. EPS,
BVPS and ROE are the most significant factors
able to explain the variations in the market price. So
multiple regression models has been developed
based on these significant variables taken from each
model.
Predictive power of this model was at high level
and has been improved due to the explanatory
power of EPS, BVPS and Return on equity selected
from the different valuation models of the study.
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This section test and measure the valuation stocks to know the undervalued and overvalued
accuracy of P/E Model, P/B Model and CAPM stocks as on 31 March 2019.
using Mean Absolute Percentage Errors. It has also
studied the signed valuation errors of models for 30

Table – 1.4 Predictive Power of Capital Asset Pricing Model

R R Square Adjusted Std. Error of the Estimate Durbin-Watson

R Square

.092a .008 .000 952.95 .390

Regression Coefficient

Unstandardized Std.
Model Coefficient Coefficients t Sig.
B Std. Error Beta
Constant 592.466 276.32 2.144 .033
Beta -163.31 127.42 -.071 -1.282 .201
Rm 2.193 2.186 .060 1.003 .316
Rf 3419.81 3656.31 .057 .935 .350

Table – 1.5
Predictive Power of Developed Model
Adjusted
R R Square Std. Error of the Estimate Durbin-Watson
RSquare
.632a .400 .394 741.53 .658

Estimating Intrinsic Value using Price to PE = Market Price/ EPS

Earnings Model
Estimated Price or Intrinsic value is then
Price to earnings coefficient is a function of company’s
calculatedby using the following formula,
beta, growth rate, pay-out ratio and earnings per share
.Relationship between the variables is studied by Intrinsic Value = Predicted PE * EPS,
regressing the expected growth in EPS, beta Where ,
coefficient and DPR against average price earnings Predicted P/E = β0 + β1BETA + β2 EPS g+
ratio to predict the price earnings ratio on yearly β3DPR+εi
basis. Relative Price to Earnings Model looks at the Estimating Intrinsic Value using Price to Book
relationship of the price earnings ratio of each Vale Model
Sensex stock to the price earningsratioof Sensex
onpredictingtheintrinsicvalue. P/B coefficient as a function of return on equity
ratio, dividend payout ratio, EPS
In Price/Earnings ratio, PE for each stock is
growthrate,Bookvaluepershareandcompany'sbeta. A
derived using the following formula.
direct test and relationship between expected
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growths in EPS, beta co as

efficient,returnonequityandpricetobookvalueratioiss
tudiedbyusingregression analysis. Relationship
between the variables is studied by regressing the
expected growth in EPS, Beta coefficient and return
on equity against average price to book value ratio.
Estimated price or intrinsic value is then calculated
by using the followingformula:
Intrinsic value = Last year Market Price + [Last
year market Price* Expected return]
Where Expected Return
E [Ri] = Rf + βeta(Rm – Rf)
E [ Ri ] = Expected return Rf = Risk-free rate
of return R m = Expected market return

Intrinsic value = Predicted PB *BVPS

Descriptive statistics of MAPE & BIAS of
Where Predicted P/B = β0+ β1BETA + β2 EPS g + P/E Model, P/B Model and CAPM was
β3 ROE + β4 DPR + εi measured for 11 years from 2007-08 to 2018-
19. The results are summarized using
Estimating Intrinsic Value using Capital Asset
descriptive statistics such as Mean of MAPE
Pricing Model
& BIAS are given for the absolute valuation
Model brings prediction of intrinsic value on the errors, signed percentage errors, in the P/E
relationship that observed between the risks of a Model, P/B Model and CAPM. Mean of
stock and its expected return. CAPM emphasizes on MAPE comparison between models will
calculating the expected return of a security. The suggest the suitable equity model which can
CAPM states that the return to investors has to be be used for valuing the stock included in the
equal to: Sensex. Mean of BIAS for 12 years state
• The risk-free rate whether the stock is undervalued or
• Plus a premium for the stocks as a whole that overvalued in nature based on the long term
is higher than the risk- free rate. fundamentals. If Mean of BIAS is positive,
Stock is overvalued and Mean of BIAS is
• Multiplied by the risk factor for the
negative, then the stock is undervalued in
individual company.
nature.
Estimated price or intrinsic value, is then calculated
Table 1.6. Sensex - Stock wise MAPE and BIAS of P/E Model, P/B Model and CAPM from 2007-08 to 2018-
19 Descriptive Statistics ( in %)
Equity Model P/E Model P/B Model CAPM Accuracy
Company Name Mean of Mean Mean Mean Mean Mean Suggested
MAPE of BIAS of MAPE of of of Equity Model
BIAS MAPE BIAS
Asian Paints 86.22 24.23 347.32 325.75 29.56 22.32 CAPM
Axis Bank 144.44 -97.50 199.30 -206.9 16.12 5.59 CAPM
Bajaj Auto 71.87 -76.94 25.44 -27.75 26.21 19.92 P/B
Bajaj Finance 115.71 -115.71 95.63 -32.95 75.59 62.10 CAPM
Bharathi Airtel 223.38 -256.62 37.13 -15.40 13.72 -8.53 CAPM
Coal India 83.58 -69.38 53.35 -16.55 10.20 -7.88 CAPM
HCL 91.14 -92.61 57.72 -62.97 31.40 21.84 CAPM
HDFC 77.32 -74.64 37.89 12.47 9.96 4.17 CAPM
HDFC Bank 121.32 -135.20 50.78 -55.39 12.99 12.29 CAPM
Hero Motors 87.11 -87.11 19.77 -17.86 28.52 10.33 P/B
HUL 76.17 -82.16 61.70 67.30 19.99 15.09 CAPM
ICICI 284.56 -275.50 58.66 -56.56 10.07 -1.55 CAPM
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INDUSIND 127.57 -139.93 23.27 -2.28 40.43 29.66 CAPM

ITC 80.72 -80.72 30.26 -11.61 17.19 8.86 CAPM
Kotak Bank 129.53 -129.53 51.59 20.15 18.01 13.88 CAPM
L&T 125.15 -81.38 38.45 -29.29 13.47 -2.19 CAPM
M&M 131.85 -131.85 47.89 -52.24 19.49 12.28 CAPM
Maruthi 187.93 -61.98 25.11 7.71 24.94 13.25 CAPM
NTPC 269.96 -46.19 54.23 -59.17 12.42 -7.46 CAPM
ONGC 137.17 -134.21 65.13 -71.05 12.66 -8.75 CAPM
Power grid 138.03 -138.03 38.93 -42.47 14.14 1.58 CAPM
Reliance 110.55 -110.55 57.50 -61.42 19.60 2.39 CAPM
SBI 132.12 -132.12 62.25 -63.66 13.08 -3.41 CAPM
Sun Pharma 104.09 -96.53 565.03 519.48 26.56 10.65 CAPM
Tata Motors 183.12 39.58 583.45 492.34 70.87 33.58 CAPM
Tata DVR 159.90 -.456 644.79 564.37 47.31 17.44 CAPM
Tata Steel 218.32 -218.32 65.17 -71.10 21.75 -7.23 CAPM
TCS 82.42 -82.42 46.90 -39.67 20.07 16.56 CAPM
Vedanta 104.07 -73.90 97.42 -103.6 46.61 6.71 CAPM
YES Bank 126.47 -126.47 65.46 -70.91 38.99 17.62 CAPM
Mean Mape 133.72 -102.81 120.25 27.96 25.39 10.37 CAPM
Note: Results computed using SPSS 17.1
CAPM produced more valuation accuracy as value with market price of each model to select the
compared to other valuation models in the stock best model based on its statistical significance.
market. CAPM Model is more complex in nature,
so the predictive power of the model is very less. H02: There is no significant relationship
But the model produced less valuation errors. between intrinsic value and market price of
CAPM can be used for valuing 28 stocks with less equity models for Sensex stocks in India
MAPE for investors in the stock market. P/B Model There is no significant relation between intrinsic
is suitable for valuing Bajaj Auto, Hero Motors. value and Market price of
Next section determines the reliability of three H02a: P /E Model ; H02b: P/B Model ; H02c:
equity valuation models by comparing the intrinsic CAPM

Table – 1.7Testing the Reliability of Price to Earnings Model using Simple Regression

R Adjusted R Std. Error

MODEL R Sig.
Square Square of the Estimate
P/E Model .014a .000 -.003 953.147 .799
P/B Model .491a .241 .238 830.824 .000
CAPM .942 a .888 .888 319.489 .000
It pricing model for Sensex stocks in Indian stock
showsthesimpleregressionresultsfortestingtherelia market. There is significant and positive relation
bilityofthe Price to Earnings Model, Price to book between intrinsic value and market price of P/B
value model and Capital asset pricing model for Model also.
Sensex stocks. As the p value is less than 0.01, the
null hypothesis, H02c, is rejected. Thus, there is a V.CONCLUSION
significant and positive relationship between Stock valuation is the complex process and this is
intrinsic value and market price of Capital asset due to the complex factors influencing on the
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valuation of stocks. Valuation models such as P/E
Model and P/B Model were not able to predict the
intrinsic value of Sensex stocks very accurately in
the Indian stock market. Relative valuation models
are not appropriate for Sensex stocks due to the
fundamental difference in the characteristics of the
stocks included in the Sensex. But CAPM produced
more accurate value estimates in Indian stock
market. In order to get a better understanding of the
accuracy of the results from the models, it was
observed that mean absolute percentage error
(MAPE) and signed valuation errors (BIAS)of
CAPM is better than P/E Model and P/B Model.
CAPM is the statistically proven model for valuing
Sensex stocks in Indian stock Market. All valuation
models are not dead in the Indian stock Market,
market based models still possess the ability in
predicting the intrinsic value of stocks very
accurately in Indian Stock Markets.
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1491R.
[3] Adams, Michael (2002). A comparison of alternative
approaches to equity valuation of privately held
entrepreneurial firms. Journal of Finance and
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[4] Seiji Oghishima (2002).Cross Shareholdings and
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[5] Mark Kamstra (2003). Pricing firms on the basis of
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