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P/E Ratio, P/BV Ratio & Dividend Yield Analysis of Nifty50 : And how we can benefit from it

Dev Ashish

In last post, we detailed how we plan to change Stable Investor’s approach in future. This post is first step in that new direction. In this post, we analyze how a little effort on one’s part can help ensure that one does not enter Indian markets when they are irrationally over-optimistic and chances of a major fall are quite high.
 
For this, one needs to know the current value of P/E Ratio, P/B Ratio & Dividend Yield (DY) of any of the benchmark indices. Though we have chosen Nifty50, you can also go for Sensex or broader NSE500, BSE500 indices. The latest values of P/E, P/B & DY can be found here. 

But the current data needs to be compared with past trends. We did some analysis of available historical data (Since Jan 1999) and found some interesting insights.

P/E Ratio (What is PE Ratio?)

The table below shows that on investing in a market with PE multiple of less than 12, returns over 3 & 5 year periods have been close to 40% per annum!! Even Warren Buffett has achieved 28% CAGR 😉 An investment in markets with PE in range 12-16 also gives a handsome return of close to 28% pa over a 3 year period. And our analysis reinforces expert’s opinion that investing in markets with high multiples (PE>24) is foolish and returns have been found to be in negative (-7%).


Caution – Five year returns do not follow the same pattern as 3-Year returns. Even on investing at foolishly high PE of more than 24, data shows that one can earn close to 26% pa for the next 5 years. Though data is correct and calculations have been thoroughly checked, we think that this should not be taken as a general rule. This is more of an outlier (due to high returns in Dot com boom and great Indian Bull run of 2003-2008). The fact is that investing in high PE markets increases the chances of low (and negative) returns. A graph below shows that PE Ratio and returns earned over 3-5 years period are inversely proportional.

PE Ratio & Returns (Click to enlarge)

P/B Ratio (What is P/B Ratio?)

The table below shows that on investing in a market with PB Ratio of less than 3, returns over 3 year periods have been close to 27% pa. But on the other hand, if one takes the risk of investing in markets which are trading at P/B of more than 4 (According to us, a market that is running ahead of its asset based fundamentals), one should be ready to accept very low returns of 4-5% pa.


Caution – Like in case of P/E Ratio, it is found that five year returns do not follow the same pattern as 3-Year returns. On investing at high P/B of more than 4, data shows that one can earn close to 23% pa for the next 5 years. This is foolish! Though data is correct and calculations have been thoroughly checked, we are not convinced with this result. Investing in markets trading at high PB levels increases the chances of low (and negative) returns. A graph below shows that P/B Ratio and returns earned over 3 year periods are inversely proportional.

P/B Ratio & Returns (Click to enlarge)


Dividend Yield (What is Dividend Yield?)

First things first. Dividend Yield (DY) of more than 2.5% for an index (Nifty50 in this case) is rare. Very rare! In last 13 years i.e about 3400 trading days, DY has stayed above 2.5 for just 130 days! And returns on investments made during those period have been an eye popping 41 & 45% for three and five years respectively!! So when can one find these days of high DYs? These are the days when markets are over pessimistic and everyone else is selling everything. There is blood on the street. And, if one has the knowledge of historical data like detailed above, one can take a call and invest in an index and be quite sure that he stands to gain handsomely in years to come. Similarly, an investment below an index DY of less than 1.5 does not make sense and returns are close to zero (6% to be precise).

Caution – Like in previous two cases, five year returns do not follow the same pattern as 3-Year returns. But rest assured, investing in markets trading at high dividend yields increases the chance of (very) high returns. A graph below shows that Dividend Yield of index and returns earned over 3 year periods are directly proportional to each other.

Dividend Yield & Returns (Click to enlarge)

So how can one benefit from these historical trends at present? As already said, we first need to get the current values of the 3 parameters. These are taken from NSE’s website.


So what does the historical data tell about the current market levels?
  • An investment at PE = 17 will give returns of 13% pa for next 3 years. (We are intentionally omitting 5 year returns data as we are not sure of its relevance – Read Caution Statement in part pertaining to PE Ratio above).
  • An investment at P/BV = 2.9 will give returns of 27% & 37% pa for next 3 & 5 years respectively.
  • An investment at Dividend Yield = 1.62 will give returns of anywhere between 6% to 26% (We are giving a range because thought the DY=1.62 lies in bracket for 26% returns, the fact remains that it is also very close to lower bracket of Below 1.5, which has a return of close to 6%)

*By investment, we mean investment in an index (via Index Fund or ETF) and not any particular stock in the index.


Though readers are free to draw their own conclusions, we thought that we would put down a few of ours –
  • If you invest in markets trading at lower multiples (PE<16) OR PBV2.5, you are bound to make some serious money in a few years time.
  • If you have some money which you want to park (at one go) in some index fund or ETF which tracks the index, we suggest that you should wait for levels when most of the markets health indicators discussed in this post are in your favor.
  • But if you are one of those disciplined investors who avoid timing the markets, then you should continue investing on a regular basis without any regard to bull or the bear markets. But you need to pray that when you need your money, it should be during the reign of bulls 😉
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