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.