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

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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 😉

22 comments

  1. Long term investors should try to be fearful when others are greedy and greedy when others are fearful.

    All in all superb analysis.

  2. @13ca7458beba0e3d76d4c70b62189d2a:disqus

    You are right that developing nations do command higher PEs than mature markets. But the tables used in above post are based on data of last 12-13 years, which covers both pre- and post- recession periods.

  3. Dear Stable Investor,

    Gr8 article. After reading the article, one thought immediately came to my mind. Such low PE levels (in range 12-16) are not sustainable for long periods of time because savvy investors will take long positions in large numbers. To prove my point, I did an analysis on NSE data for past 13 years. The result is pasted below–

    It shows that these ratios alone cannot accurately guide investors as to when to plunge into the market or leave the market.

    Please let me know your views about this.

  4. @e8b6ee53551268660e6a5cc9de944243:disqus

    Interesting thoughts Hemant…
    But as you rightly said, such low PE levels are not sustainable. One has to be sure about when to take a big bet. As Warren Buffet rightly said, one has to back his COURAGE with CASH in times of CRISIS. 🙂

    PS – You have rightly pointed out that savvy investors will take long positions, which in turn increases the average PE ratios of bad years like 2008-09.

  5. if i take dividend yield from BSE it is very different from that on nse for the broad market (not merely Sensex and Nifty indices). Espacially during the 2012 cy. BSE shows a dip in div. yield during 2012 but nse does not! Any ideas?

  6. @disqus_G3jFUHVwEM:disqus
    Generally speaking, it should not happen for individual stocks. Yield will only be different in case there is a difference in CMPs of the 2 exchanges.
    Can you elaborate a little on what exactly do you mean when you say BSE, NSE? Or can you share the source of the data?

  7. It is irritating me because according to BSE indications are that markets are going to make a sharp upmove and I was planning to punt on it. Since Nifty and not BSE – Sensex is actively traded in derivates, I cross checked it at NSE and this is baffling. NSE indicates that upmove wouldnt be sharp. Any inputs would be appreciated.

    I took data from bseindia and nseindia websites for dividend yields. http://www.nseindia.com/products/content/equities/indices/historical_pepb.htm
    and
    http://www.bseindia.com/indices/IndexArchiveData.aspx?expandable=3

    I am trying to paste the results below and also attaching graph of the following data. Dividend yields according to bse100, nse 100 for first day of the months are –

    Oct-11
    BSE100 – NSE100 div. yld.
    -0.03
    BSE 100 –
    1.49
    NSE 100 –
    1.52

    Nov-11
    BSE100 – NSE100 div. yld.
    -0.01
    BSE 100 –
    1.42
    NSE 100 –
    1.43

    Dec-11
    BSE100 – NSE100 div. yld.
    -0.01
    BSE 100 –
    1.52
    NSE 100 –
    1.53

    Jan-12
    BSE100 – NSE100 div. yld.
    -0.01
    BSE 100 –
    1.63
    NSE 100 –
    1.64

    Feb-12
    BSE100 – NSE100 div. yld.
    -0.05
    BSE 100 –
    1.44
    NSE 100 –
    1.49

    Mar-12
    BSE100 – NSE100 div. yld.
    -0.08
    BSE 100 –
    1.4
    NSE 100 –
    1.48

    Apr-12
    BSE100 – NSE100 div. yld.
    -0.07
    BSE 100 –
    1.43
    NSE 100 –
    1.5

    May-12
    BSE100 – NSE100 div. yld.
    0.13
    BSE 100 –
    1.64
    NSE 100 –
    1.51

    Jun-12
    BSE100 – NSE100 div. yld.
    0.13
    BSE 100 –
    1.77
    NSE 100 –
    1.64

    Jul-12
    BSE100 – NSE100 div. yld.
    0.13
    BSE 100 –
    1.63
    NSE 100 –
    1.5

    Aug-12
    BSE100 – NSE100 div. yld.
    0.12
    BSE 100 –
    1.65
    NSE 100 –
    1.53

    Sep-12
    BSE100 – NSE100 div. yld.
    0.1
    BSE 100 –
    1.66
    NSE 100 –
    1.56

    Oct-12
    BSE100 – NSE100 div. yld.
    0.11
    BSE 100 –
    1.53
    NSE 100 –
    1.42

    Nov-12
    BSE100 – NSE100 div. yld.
    0.13
    BSE 100 –
    1.56
    NSE 100 –
    1.43

    Dec-12
    BSE100 – NSE100 div. yld.
    0.11
    BSE 100 –
    1.5
    NSE 100 –
    1.39

    Jan-13
    BSE100 – NSE100 div. yld.
    0.09
    BSE 100 –
    1.47
    NSE 100 –
    1.38

    Feb-13
    BSE100 – NSE100 div. yld.
    0.09
    BSE 100 –
    1.45
    NSE 100 –
    1.36

  8. @disqus_G3jFUHVwEM:disqus

    Not sure how to answer your query. May be we are unable to understand since we aren't into derivatives or technical analysis.
    But, what is the point of calculating the difference between the Dividend Yields of 2 separate indices over a period time? Does it offer some kind of insights? We are asking because both indices may have different constituent stocks and also the stocks are regularly added or removed from individual indices.

  9. Dear team
    I came across this website recently and would like thank you for the great work done. I have been reading all articles one by one. This particular article is a great one which will definately help the small investors. Since I am new to equity investing, i have the following questions –
    1. PE /PB/ DY values for the index are taken from NSE website. How is the calculation of PE / PB done for an index as it constitutes a number of stocks with different weightages ? Merely taking average PE of all stocks in the index would be incorrect as each one of them has a different weightage. I tried to get answer to this in NSE website but cound not get it.
    2. Are there index funds for each of the NSE index ? for example, i want to invest in NSE midcap index . But i could not find any ETFs for this index. Is there any other way to invest in an index other than ETFs ?
    Could you please anwer this ….. Once again thanks for the great blog

  10. Thanks for the nice words Ananth. 🙂

    This article tells us why it makes sense to learn from the past. Once a person is familiar with past trends, it helps in avoiding markets when they are heated up.

    As for your first question, you can use following logic:

    P/E = Price of share / Earning Per Share

    If we multiply both numerator and denominator by same number, the ratio would not change. Therefore we have,

    P/E = (Price of share * No. of shares ) / (Earning Per Share * No. of shares)

    which is same as,

    P/E = (Market Capitalization)/(Net Profits) of the company

    The above example is true for an individual company. The same can be extended for the index.

    P/E of index = (Market Cap of all companies) / (Net profit of all companies)

    This would give a approximate value of index's P/E ratio, or for that matter P/BV and Dividend Yield.

    For your second question, I would try to do a detailed post.

    Hope the above example addresses your concern.

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  12. hi Dev, i recently came across your blog and started reading and liking its analysis. I have 5 L surplus to invest in markets, but after reading your site and looking at current sensex PE, PBV, DY it looks that levels are not favorable, I am ready to wait for appropriate time to put this fund in market, but until that time should I put this in liquid fund or just keep in saving a/c? I can wait for 1 year till find right levels to enter, let me know.

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