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It seems like a season of Excel-based Analysis. You must have noticed that majority of the posts I have been doing in last 1 or 2 months, use Excel-based analysis. Though there is no particular reason for this, here I am back again with another analysis. Don’t worry…it’s not a very complex analysis. It’s simple and very useful…
Regular readers would be familiar with my ‘fetish’ for tracking State of the Indian Markets on a monthly basis. And I make it a point to update the data set every year to update the yearly returns calculations. I have been doing this every year since Stable Investor started, i.e. in 2012, 2013and 2014.
So this post is about analyzing P/E Ratio of a popular index Nifty50 and the returns earned in 3, 5 and 7 year periods, when we invest (theoretically) in the index.
But before I move forward, you might question the rationale of doing such an analysis. And that too, on a regular basis. The reason is very simple. This small effort ensures that I have a broad idea about the valuations of overall markets. It helps ensure that I am not entering markets, when they are over-optimistic. This in turn reduces the chances of making mistakes when investing for long term.
It also helps me in knowing when the overall mood of the market is dull and full of pessimism. In past I have been unable to utilize such times to invest heavily. But I do not want to miss out on such opportunities in future. I hope you understand what I mean… 🙂
So let’s go ahead with my findings…
The data has been sourced from NSE’s website (link 1 and link 2) and starting from 1st January 1999. Ratio related data prior to this period is not available.
So here is the result of the analysis…
The table above clearly shows that if one is investing in markets where PE<12, returns over the next 3, 5 and 7 year periods are astonishing 39%, 29% and 25% every year. That is money doubling almost every 2-3 years!!
But markets with PE below 12 are very rare. To give you an idea about the rarity, the markets have been available at PE<12 on only about 50 days since 1999, i.e. in 4000+ trading days!!
Though as average investors, it’s almost impossible to wait for such days, it shows the power of long term, patient investing for those who know when to wait and when to jump in the markets.
On the other end of the spectrum is PE above 24. These are levels which are quite overvalued and returns over the next 3, 5 and 7 year reduces to (-)5.1%, 2.7% and 9.9%.
This shows that if you invest in high PE markets, your chances of low (and even negative) returns increases substantially.
And for your information, we are currently trading at PE=24 😉
But here is another interesting thing to note here. Even at a costly PE24, if an investor stays invested for more than 7 years, then average returns are still a very decent 9.9%. And this shows that longer you stay invested, higher are the chances of making money in stock markets….even if you have entered at higher levels (Caution: I am talking about index investing here and not individual stocks).
If you are still not convinced with the data shown in above table, I have a few graphs for you. These graphs have been plotted to show the exact Returns against the exact PE on a daily basis (though arranged with increasing PE, PB and decreasing Dividend Yields).
Three graphs – one each for 3-Year, 5-Year and 7-Year Rolling Returns:
The left axis shows the PE levels (BLUE Line) and the right axis shows the Returns (in %) in the relevant period (Light Red Bars)
The 3 Year graph clearly shows that lower the PE when you invest, higher are the chances of making good returns in short term like 3 years and 5 years (graph below). Yes… I consider 3 and 5 Years as short term. 🙂
Now, interesting thing about 7 Year graph below is that there are no negative returns. 🙂 What does it mean? It means that it is very difficult to earn negative returns if you invest for long periods like 7 years, 15 years or even 30 years!!
Next I will be sharing my findings on a similar analysis for Price-To-Book-Value Ratio, followed by one for Dividend Yield of the Nifty since 1999. Hope to do it in a day or two.