P/E Ratio Analysis of Nifty – February 2016 Update

Note – I have updated this analysis in 2017 here.

I had been working to make this analysis more useful. Like all previous updates, this one too has index (Nifty 50) analysis of 3, 5, and 7 years. But this time, I have also added an analysis of 10-year returns. Since most readers of Stable Investor are interested in long term investing, it made sense to add an analysis for a longer tenure.

In addition to that, I have also incorporated few more tracking points to give a more comprehensive P/E based picture. The details will become evident as you go through this analysis.

In case you are interested in reading previous years’ analysis, then you can access them here: 2012, 2013, 2014 and 2015. (The latest summaries are available in tab named State of Market)

So what exactly is that this analysis tells?

To put it simply, it tells that it makes sense to invest (if possible, more) when general indices are trading at lower PEs. This statement is based on last 17 years’ worth of analysis.

But mind you, there is ofcourse no guarantee that the trends might continue in future.

So this analysis tells about the possible returns one can get when the money is invested (in index) at various PE ratios.

Let’s go ahead with the updated findings…

As you can see, there is a big difference between the minimum and maximum returns for almost all periods. So the returns that you will get will depend a lot on when exactly you enter the market. Yes, it sounds like timing the market. But this is a reality. For those who can, timing the market works beautifully.

But point is that most people can’t – And this is the reason why they shouldn’t try it either.

Hence even though the average returns give a good picture for long-term investors (look at the table for 10 year), its still possible that you end up getting returns that are closer to the ones that are shown in minimum (10Y Returns) column and not the average returns. 😉

This is another reason why I introduced the column for standard deviation in all tables above (see last column).

Analyzing standard deviation tells you – how much the actual return will vary from the average returns. So higher the deviation, higher will be the variation in actual returns. I strongly recommend you read this post on importance of Standard Deviation by Prof Pattabiraman here.

Now, lets touch upon a very important point. Buying low makes sense. So should you wait to only invest at low PEs? Though it might make theoretical sense to do it, fact is that it is very difficult to wait for low PE markets.

Look at the time spent by the index at sub-PE12 levels.

It is just about 2% of the time since 1999 (Ref: Column name ‘Time Spent in PE Band’ in tables above).

Markets at below PE12 are extremely rare. For common investors, it’s almost impossible to wait for such days – that might be spaced years apart.

Another useful thing to note here is that as your investment horizon increases, the expected returns more or less are good enough, even when one invests at high PEs.

So, even if an investor puts his money in the index at PE24, the expected average returns are more than 12%. That’s pretty good enough.

And what about the maximum and minimum achieved since 1999?

At 13.8% and 10.5% respectively, these are not bad either. This is what really shows that if you are investing for long term, equity is your best bet for wealth creation.

The longer you stay invested, higher are the chances of making money in stock markets….even if you have entered at higher levels. On the contrary, if someone was thinking to invest at high PEs (above 24) for less than 3 years, then I am almost certain that this person will lose money.

Recommended Reading:

1. Becoming a Value Investor using Nifty PE Ratio
2. A Small Guide I refer to when investing in Stock Markets

Now you might be tempted to ask – what is it that I do with my own money (after knowing all this since I have been doing this analysis for past many years)?

The answer is that I have tried to keep my financial life simple.

I have few base SIPs running all the time. I don’t disturb them whether it’s a low PE market or a high PE one.

Since I am also interested in giving booster shots to my long-term returns, I invest additional amount when I feel comfortable with valuations on the lower side. I also keep a Market Crash Fund that I use every now and then. I have covered about it in detail here, hereand here. But I don’t recommend that approach to anyone. It’s for people with time and intent to track markets closely.

For most readers, knowing the market PE gives a broad idea about the valuations of overall markets. It helps ensure that you know when the markets are over-optimistic and hence, it reduces the chances of making mistakes when investing. It also helps in knowing when the overall mood of the market is down and probably, full of more than necessary pessimism. Let your base SIPs run irrespective of market levels. But see if you can benefit from some of the insights that analysis like above provides. 🙂

Reminder: I am talking about index-valuations here and not individual stocks.

A reader had asked me to create a PE chart to show monthly changes in Nifty valuations. Heat Map below shows monthly Nifty valuations – based on index’s monthly average PEs.