The markets are falling. Experts all over are painting the picture of India’s economic future with dark colors. People around you are selling shares and stopping SIPs in mutual funds.
So what exactly is happening? We tried answering this question in one of our previous posts titled What’s happening to stock markets, economy & your portfolio. Many people known to us are exiting markets because markets have not produced any return for last 5 years. In fact, it has gone into negative territory in this 5 year period. But this very fact should have forced a sensible investor to think rationally and stay put in market. We did a small study some time back and came up with a conclusion that “If returns in last 5 years have not been great, chances of making higher returns in next 5 years are quite high.”
In fact, we started this website with posts evaluating traditional valuation parameters like PE etc for Indian markets. And surprisingly, we found a really interesting pattern which showed that Indian markets have a tendency to bounce between PE multiples of 12 and 24!!(see how here).
So we decided to see where exactly are Indian markets placed in terms of PE multiples when compared to historical levels.
As of now, Nifty (a benchmark index) has a P/E Ratio of 15.7. Now when compared with past data, this is not expensive at all (considering growing nature of Indian markets). But this time around, problems surrounding us (& lack of solutions) are forcing us to question the very nature and sustainability of India’s growth. Therefore, this PE Ratio of 15.7 cannot be considered to be cheap either.
So does it mean that markets will go down more? Does it mean that Indian markets are going to be re-rated soon? Frankly, we don’t have answers to such speculative questions. But yes, times ahead do seem to be tough and only tough and robust businesses will survive.
Nevertheless, we ran up some calculations and found that there is some correlation between overall market PE levels and return which you can expect to earn over a 3 or 5 year period. Table below shows the same and is quite self explanatory –
To summarize, lower the overall PE levels of market, greater would be your return over a 3 year or 5 year period.
Assumptions – This analysis is based solely on Nifty’s past data. Same may not be repeated in future. But chances of repetition are quite high. Returns offered by individual stocks may wary quite a lot from this data.
Interesting post with food for thought! 🙂
The PE is 15.77 as of 30 th aug… Why do you say it's 16.2? Is that consolidated PE?
Thanks for pointing it out. We had actually taken last month's average PE to show the trend. But since 15.7 is the actual data as on 30th August 2013, it supports our view further. And we have updated the table now.
You are welcome. The 15.7 is a stand alone PE.. The exchanges are not reporting consolidated PE… I remember an ET article where it quoted consolidated PE will be approximately say 2 less than standalone PE which comes to 13.7 making the markets dirt cheap… Ur thoughts on that.. I know it's lot of work to get that… Any thoughts on getting that info?
Even if you just consider the stand alone PEs, market does not seem to be overvalued (I won'say undervalued as I still have a feeling that market bottoms may be far away).
And since consolidated and standalone PEs are interdependent (to an extent), cons. PE would show a pretty much similar trend.
The only problem is the E of the PER. We are looking at historical values of E. The way the economy is shaping and the way there might be global gloom and doom, GDP slipping below 4.5% and probably below 4% by now, the E has probably shifted significantly south. Which means PE is probably 18 or 20 as per latest E…so pls. be careful when you use such metrics without thinking!
True. Earnings are what businesses are all about. As far as the Price is concerned, its determined by demand and supply, rational and irrational exuberance(s) of the crowd. Even if the economy does head down for a while and the EPS does go down with it, it will definitely provide a golden opportunity for long term investors to pick up shares of good, strong and proven businesses at throwaway prices. And that is what should bring a
smile to any long term investor’s face.
But what happens in reality is that everytime there is bad news in market, an average investor’s initial reaction is – “this time this is different and
everything is going to end”. But history repeats and rhymes. Those who use their cash and courage to buy shares during crisis, live to tell their successful and profitable stories. For those who moved out of the market at a time when they should have been heavily investing, also live to tell their side of a sad story of losing out on possible multibaggers
this is really amazing study, i accidently put up to this site.
One qn plz – Do we need to refer standalone data or consolidated data , this confusion arises because sometimes consolidated data have negative EPS(means no P/E ratio) but on same time standalone data have positive p/e.
Thanks Prateek 🙂
The study is based on index level PE data made available by exchanges.