Where is the market heading? What’s in it for you? Is more downside possible?

Where is the market heading? What’s in it for you? Is more downside possible?

After a short consolidation in the last 10 days of January, the bears have again taken control of the market. This has been majorly attributed to the mounting NPAs or bad loans that many leading PSU banks, including Bank of Baroda, Bank of India, IDBI Bank and UCO Bank have reported. In December 2015 alone, nine state-owned banks have reported a combined loss of Rs. 11,251 crores. Surprisingly, HDFC Bank, who is India's second largest private lender, now has a market capitalization equal to that of all the PSU banks put together. Yes, the post-budget session has shown some respite, but will it continue?

Markets will yo-yo further, but we as investors always have to understand that good times are inevitably followed by bad and bad by good. Before we prove this claim, we need to understand a few concepts including the P/E Ratio, P/B Value and Dividend Yield of the popular Nifty50 index. As of 29th February 2016 , those values are:

  • P/E ratio: 18.90
  • P/B ratio: 2.81
  • Dividend Yield: 1.66%

These concepts are so helpful that you’ll want to reread this article several times until you’ve understood them and could use their applications for the rest of your investment life.

So, what does the P/E ratio of an index mean? What are the indicators?

Similar to that of a company, Nifty50 P/E ratio measures the weighted average P/E Ratio of the companies covered by the Nifty index and is broadly used to identify how cheap or expensive the index is. It is calculated by dividing the sum of market capitalization by the sum of consolidated earnings of all companies which constitute the index.

It is interpreted for the Nifty50 as follows:

  • BUY Signal: Once the P/E ratio goes below 18 (UnderValued Range).
  • SELL Signal: Once the P/E ratio goes above 24 (OverValued Range).

Also, according to our research on the past 15 years’ data, it is inappreciable to invest in Nifty50 when its P/E ratio starts to exceed the 20-22 range. Everytime the value surpasses 22, the average returns given by the index in 3 years is way lesser than that given by Fixed Deposits (25%). Here’s the corroboration:

P/E ratio P/B ratio Avg. Div Yield Av. 3Y Nifty50 Returns%
<14 2.61 2.29 149.05%
14-16 2.99 1.8 116.00%
16-18 3.3 1.51 53.47%
(Range on 29th Feb, 2016) 18-20 3.65 1.39 35.95%
20-22 4.04 1.24 15.48%
22-24 3.89 1.15 -1.84%
24-26 4.81 1.02 -1.41%
26-28 6.33 0.86 -2.23%
28-30 6.54 0.82 -4.94%

And what does the P/B ratio of an index mean? What are the indicators?

Applying the same analogy as above, P/B ratio of an index is the weighted average P/B ratio of all the stocks covered by the index, Nifty50 in our case. Formulawise, dividing the current closing level of the index by the latest quarter's book value per share (average of all companies) gives you the Price-To-Book ratio of Nifty50. In simpler terms, the stock price of an entity always has two values - one that assigned by the accountant which is called the book value and the other assigned by the market which is the traded stock price. The former does not take into consideration the value of intangible assets like patents, brand value, intellectual property, etc and hence is comparatively lower in most cases.

Talking numbers, a P/B ratio of around 2.75 to 3.50 is usually considered fair valuation for the index. Its interpretation is as follows:

  • BUY Signal: Once the P/B ratio goes below 2.75 (UnderValued Range).
  • SELL Signal: Once the P/B ratio goes above 3.50 (OverValued Range).

Lastly, what is the Nifty50 Dividend Yield and how to interpret it?

Like the above two ratios, it is basically the weighted average dividend yield of all the Nifty50 companies. Dividends are one way of distributing the profits to the shareholders. The Dividend Yield of a company can be calculated by dividing its annual dividend per share by the traded price of the share.

It is expressed in the form of percentage and a fair value for the index bounces between 1-1.5%. They are read as:

  • BUY Signal: Once the Div Yield goes above 1.4% (UnderValued Range).
  • SELL Signal: Once the Div Yield goes close to 1% (OverValued Range).

Further, we’ll show more proof on how useful it is to analyze these ratios and make informed decisions.

Below given is the P/E ratio, P/B ratio and Dividend Yield of the Nifty50 index over the past 15 years. Let us analyze and prove whatever that has been claimed in the article till now:

Nifty50

Observation 1- All bull markets are followed by phases of undervaluation and vice versa. In other words, all good times are inevitably followed by bad and bad by good.

Example: Nifty was enjoying its dream run during the period from January 1999 to December 1999 which was fueled by the global dot-com bubble. This was followed by an evident dot-com burst in 2001 leading to an elongated undervaluation phase during 2002 to 2004. The Nifty P/E was range bound around 12-13, with a P/B value of around 1.9-2.2 and a Dividend Yield of 1.5-1.65%.

By mid 2004, ultra cheap credit and mortgages caused the then ongoing bull run in the housing sector to soar in a parabolic fashion, creating an explosion in demand for construction workers, mortgage brokers and realtors. People started spending freely and it was perceived to be as a recovery from the previous bear market. But what economists, business leaders and politicians did not realize that it was built on the back of an unsustainable bubble which eventually burst in 2008 and led the world into a recession. Although India did not contribute much to this sub-prime mortgage crisis, it was and has always been affected heavily by global turbulences, like the recent China slowdown. The Nifty P/E at the start of the burst was around a whooping 28.57 with a P/B value of around 6.5 and a Dividend Yield of 0.85%. All these indicators were enough for it to show that a fall was imminent and that is exactly what happened.

The markets were battered till the mid 2009 period post which we witnessed another bull run.

Observation 2- As per the chart, everytime the P/B ratio and Dividend Yield seemed converge, the market presented golden BUYING opportunities to the investors and eventually gave handsome returns to those who grabbed that opportunity.

Example: One can see them converging between August 2001 to December 2002, and again between February 2008 to February 2009 which were basically periods of undervaluation. These were the two occasions when Nifty presented its investors with a great chance of making money.

Also, as expected, Nifty P/E was close to 12.5 with the P/B value of around 2 and the Dividend Yield of around 1.55 during the time. These indicators were screaming for Nifty to be bought as it is rare for all three of them to be in such an ideal BUY range.

Remember, we have to learn to deal with these bad or good phases without damaging our long term prospects. It is best to be patient as well as aware about these things. Smart investors BUY at correct times in a bear market when no one is interested in going long and SELL when there is a massive euphoria where everyone, I mean everyone tries to become a stock market guru. You can be right on every other stock selection criterion that we’ve discussed till now, but if you’re wrong about the timing, you will most likely erode a huge chunk of your wealth.

Now that we’ve understood the ratios and their indicators, let us see when Nifty50 showed similar values for these ratios as it is showing now and what happened next:

Date P/E ratio P/B ratio Div Yield Nifty50 Level Nifty50 Returns%
15-Dec-03 19.01 3.71 1.60 1723.95 14.98% (High of 1982.15 in 1 month)
26-Sep-12 19.02 3.09 1.46 5663.45 09.25% (High of 6187.3 in 8 months)
01-Apr-14 18.91 3.24 1.37 6721.05 35.68% (High of 9119.20 in 11 months)
29-Feb-16 18.90 2.81 1.66 6987.05 ????

As you can see, Nifty50 showed similar signs in Dec 2003, Sept 2012 as well as Apr 2014 as it is showing now and grew by delightful margins in a short span of time. Hence, do all the calculations you want, but history indicates that this is a bottomed out market now and a good time to allocate your money. So make sure you don’t miss this potential rally!

I’m sure that you can now decide for yourself where the market is heading with its current values. Also, you do not have to put much effort in calculating the Nifty P/E, P/B Ratios and Dividend Yield. Data for all the sectors is available on NSE’s website. Go on and try it for yourself! But again, keep in mind that optimism is always ahead of reality; and for uniformed investors, nothing ever indicates a crash other than hindsight.

29 comments: Where is the market heading? What’s in it for you? Is more downside possible?

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  • ahmad        
    SATISH MARATHE
    apr 11,2017 at 04:33 - Reply

    Dear sir, Article is very useful for all. i read it today morning. i shall use it. Congratulations. Thank you for providing guidance.

    • ahmad        
      Team StockAxis
      apr 17,2017 at 09:46

      Hello Mr. Satish,

      We are very happy to see that you've found the blog section useful. It is our goal at StockAxis to help investors make informed investment decisions.

      Feel free to get in touch with us in case you have any queries related to the market, we'll be happy to assist you.

      Happy Investing!

  • ahmad        
    K.P.JANAKIRAMAN
    apr 11,2017 at 12:45 - Reply

    Interesting & useful

  • ahmad        
    Gopalan
    feb 12,2017 at 05:57 - Reply

    Highly informative article. I have also been tracking for sometime. However it is found that the Nifty EPS on which the PE is based is standalone and not Consolidated. Your valuable comments pl.

  • ahmad        
    M.Padmanabhan
    dec 22,2016 at 12:19 - Reply

    So stock picking is more important than the direction of the market.

    • ahmad        
      Team StockAxis
      dec 22,2016 at 01:02

      Hello M Padmanabhan,

      Yes.. definitely..

      One should always use the market to one's own advantage and not get carried away by the herd mentality. Always keep in mind what the legendary Warren Buffett says, “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”

      Hence, every market fall should be used as an opportunity to buy quality businesses at bargain valuations and vice versa.

      You can read our article on Fear & Greed: Don’t Let Emotions Come In The Way Of Your Stock Market Success for further insights and real life examples on your query. Hope you find the read useful.

      Do let us know if we can be of assistance in any way related to your queries related to the stock market.

      Happy Investing!

  • ahmad        
    M.Padmanabhan
    dec 21,2016 at 05:00 - Reply

    Present Nifty P/E=21.16. PB=3.06. DY=1.37. I want to know whether PE goes up to 24-25 and then correct to 18-19 level OR correct first to 18-19 level and then rise to 24-25 level.

    • ahmad        
      Team StockAxis
      dec 22,2016 at 12:10

      Hello M.Padmanabhan,

      It is virtually impossible for anyone the judge the direction in which the market is set to head. Instead, one should always focus on the fundamentals of companies with sound business models and hardworking managements.

      Also, the market sentiments and directions should be used as an opportunity to to invest more in the respective companies and not to sell in panic or fear.

      Happy Investing!

  • ahmad        
    Cinels
    nov 07,2016 at 05:48 - Reply

    Thanks a lot sock axis team for this wonderful informative article.

    • ahmad        
      Team StockAxis
      nov 09,2016 at 04:49

      Hello Cinels,

      Thank you very much. We are pleased to see that you liked the article. You can also read ‘P/E Ratios: Look at them Like an Analyst!!!’ (click here) and ‘When To Buy A Stock - The GREAT PARADOX!’ (click here). Hope you find it useful!

      Till then, Happy Investing!

  • ahmad        
    Jitendra Patel
    aug 10,2016 at 10:09 - Reply

    Good and informative detailed understanding given for costly shares company n real guidelines to investors for highly priced shares and fundamental details regarding true investors

    • ahmad        
      Team StockAxis
      nov 09,2016 at 04:51

      Hello Jitendra,

      Thank you very much. We are pleased to see that you liked the article. You can also read ‘P/E Ratios: Look at them Like an Analyst!!!’ (click here) and ‘When To Buy A Stock - The GREAT PARADOX!’ (click here). Hope you find them useful!

      Till then, Happy Investing!

  • ahmad        
    Radha Mohan Reddy P
    apr 24,2016 at 12:15 - Reply

    Your analysis came true. As on 22nd april 2016, nifty gained 13% over the feb 29th level.. You people are gr8. do u offer any fundamental analysis coaching and books to read. Iam interested to know those details.

    • ahmad        
      Team StockAxis
      apr 25,2016 at 09:39

      Hello Ms. Radha,

      We are happy to see that you have been following our articles. We always analyze, be it a company or the index itself, strictly on a fundamental basis. But, we are sorry to say that we don't provide coaching 'directly'. But, to make up for that, we have been trying to educate our clients through our research-based blog.

      You can surely go through our blog for further insights into investment methodologies. If you have any queries, you can comment here, or write to us at research@stockaxis.com or even give a missed call on 97730 61000 and we will get back to you.

      Happy Investing!

  • ahmad        
    Lalit
    mar 21,2016 at 09:14 - Reply

    One of the best teaching efforts for bignners as well for learned. It provide detail information about working of market. Thank you

    • ahmad        
      Team StockAxis
      mar 28,2016 at 11:25

      Hello Mr Lalit,

      We are very happy to see that you found the analysis useful. We’ll be coming up with more such articles shortly. In the meanwhile, you can explore the other articles of our blog.

      Happy Investing!

  • ahmad        
    PRABHAKAR
    mar 11,2016 at 07:29 - Reply

    I am a small investor please your advice

    • ahmad        
      Team StockAxis
      mar 14,2016 at 03:53

      Hello Mr. Prabhakar,

      Our advisor will contact you shortly for the same.

      Till then, Happy Investing!

  • ahmad        
    swadhin kimar saha
    mar 10,2016 at 05:39 - Reply

    hi my name swadhin kumar saha. your mold techpack multibaggaer call superb. but i am small a investor. your charge is not suitable for me.....please do something for small retail investor

    • ahmad        
      Team StockAxis
      mar 14,2016 at 03:53

      Hello Mr. Saha,

      Our advisor will contact you shortly for the same.

      Till then, Happy Investing!

  • ahmad        
    jkugar
    mar 08,2016 at 04:42 - Reply

    How tecldhnically & foundmentaly tne BF Utilities strong? Shold Ihold Or exit my entry level is 812 few sevenmonth back. Pl. advice should I averaged and at what level.

    • ahmad        
      Team StockAxis
      mar 08,2016 at 09:53

      Hello Mr. JKDugar,

      Our advisor will contact you shortly for the same.

      Till then, Happy Investing!

  • ahmad        
    Kamal Roy
    mar 06,2016 at 10:51 - Reply

    Thank you very much for sending this article. Thanks to the Stockaxis team. Can you suggest two stocks where I can put my money. Kamal Roy

    • ahmad        
      Team StockAxis
      mar 08,2016 at 09:50

      Hello Mr. Roy,

      We are pleased to hear that. Thank you very much. Our advisor will contact you shortly for the same.

      Happy Investing!

  • ahmad        
    naushad khan
    mar 04,2016 at 01:49 - Reply

    Thank you

  • ahmad        
    Harish
    mar 03,2016 at 11:57 - Reply

    Harish shah Very Good analysis. very useful for Investor. Thanks to your Team Members without their efforts we will not have such good informations

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:37

      Hello Mr. Harish,

      Thank you very much. We are pleased to see that you liked the article. You can also read ‘P/E Ratios: Look at them Like an Analyst!!!’ (click here) and ‘When To Buy A Stock - The GREAT PARADOX!’ (click here). Hope you find it useful!

      Till then, Happy Investing!

  • ahmad        
    Sandeep
    mar 03,2016 at 11:01 - Reply

    Hi Friends - Though I am not as such associated with your company but I often receives your mail and trust me I admire the market understanding of you professionals. Kindly let me know what sort of services do you render. I am active in F&O segment. Can some one help me to understand the various services available.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:37

      Hi Sandeep,

      Thank you very much for your remarks. It was great to hear that. We are a SEBI registered equity advisory firm. With our thrust on technical and fundamental research, we track and advise our clients on more than 2000 listed companies.

      For more information, our advisor will get in touch with you shortly. Alternatively, you can give a missed on +91 9773076000.

      Till then, Happy Investing!

  • ahmad        
    Pradeep Mundra
    mar 03,2016 at 09:19 - Reply

    I am a very small investor n all this calculations are bit complicated. For last 1-1/2 year I have been following your recommendations. Being very small investor it's tough to be associated with you n your team. If you have something for small investor I will be grateful. Pls inform.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:36

      Hello Pradeep,

      Please let us know what part of the article did you find complicated and we’ll be happy to simplify it for you. Also, our packages suit all types of investors. Our advisor will get in touch with you shortly for the same.

      Till then, Happy Investing!

  • ahmad        
    PK Velayudhan
    mar 03,2016 at 08:46 - Reply

    very good and useful analysis. Yr readers and clients will be benefited a lot. Thanks for sending this research report. We will make use of it.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:36

      Hello Mr Velayudhan,

      We are very happy to see that you found the analysis useful. We’ll be coming up with more such articles shortly. In the meanwhile, you can explore the other articles of our blog.

      Happy Investing!

  • ahmad        
    Nushadkhan
    mar 03,2016 at 02:58 - Reply

    So gud

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:32

      Hello Mr. Nushad,

      Thanks! We’ll be following up with a Part 2 article soon.

      Happy Investing!

  • ahmad        
    Nikhil
    mar 03,2016 at 01:31 - Reply

    Very good analysis by the team. Keep it up

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:30

      Hello Mr. Nikhil,

      We are pleased to hear that. Thank you very much.

      Happy Investing!

  • ahmad        
    KULDEEP JAIN
    mar 03,2016 at 01:00 - Reply

    Good and deep research

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:29

      Hello Mr. Kuldeep,

      Thank you very much for your remark.

      Happy Investing!

  • ahmad        
    SANKARAN VENKATARAMAN
    mar 02,2016 at 11:33 - Reply

    Extremely Informative and well analysed and unbiased article .Gem of an article with superb analysis supported by hard data and to be practised by investors for all times. Thank you

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:27

      Hello Mr. Venkataraman,

      Thank you very much sir. We are very pleased to hear that and will be coming up a Part-2 article soon. You can also read ‘P/E Ratios: Look at them Like an Analyst!!!’ (click here).

      Till then, Happy Investing!

  • ahmad        
    BHAVIK
    mar 02,2016 at 10:27 - Reply

    Hi

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:27

      Dear Bhavik,

      How can we help you?

  • ahmad        
    somen mitra
    mar 02,2016 at 09:56 - Reply

    very good analysis, let us see the result of your analysis.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:26

      Hi Somen,

      Thank you very much. We’ll follow up on that very soon! :)

      Till then, Happy Investing!

  • ahmad        
    Akash Agrawal
    mar 02,2016 at 09:06 - Reply

    Can you suggest me some stocks to buy at present?

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:24

      Hello Mr. Akash,

      Our advisor will contact you shortly for the same.

      Till then, Happy Investing!

  • ahmad        
    Adi
    mar 02,2016 at 08:09 - Reply

    I was really looking for something like this. I only looked at P/E ratio , but complementing it with p/b and div yield gives even more better insight for investment decisions.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:20

      Hello Adi,

      It is great to see that you found the concepts useful. Feel free to get in touch with in case you have any queries related to the stock market.

      Happy Investing!

  • ahmad        
    Angshuman Paul
    mar 02,2016 at 07:41 - Reply

    Really helpful article.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:19

      Dear Angshuman,

      We are very happy to hear that. You can also read ‘The Impact Of New Products & New Management On The Stock’ (click here) and ‘When To Buy A Stock - The GREAT PARADOX!’ (click here).

      Happy Investing!

  • ahmad        
    J R MISTRY
    mar 02,2016 at 07:06 - Reply

    Excellent analysis.Good knowledge gathered by reading this article. I wish all wise investors must must read and keep it in their mind for ever.I sincerely thanks the stockaxis team for this valuable knowledge.

    • ahmad        
      Team StockAxis
      mar 03,2016 at 06:19

      Hello Mr. Mistry,

      Thank you very much for your remarks. We are delighted to see that you found the article useful. We’ll be coming up with such articles regularly. In the meanwhile, you can also read ‘P/E Ratios: Look at them Like an Analyst!!!’ (click here).

      Happy Investing!

  • ahmad        
    Dhandhukia kiran
    mar 02,2016 at 06:49 - Reply

    I am subscriber of stockaxis inv;This calculation is very perfect followed by example.we are thankful for this knowledge.But I don't understand that it is said that share market discounts future earning in advance.?Can you focus on this ?Thanks .

    • ahmad        
      Team StockAxis
      mar 03,2016 at 05:43

      Dear Kiran,

      We are pleased to see that you liked the article and found it useful. The answer to your query, yes, the market does discount future earnings in advance. Infact, it not only discounts the earnings of a company beforehand, but the possible impact of each and every event taking place in the entire world including the activities of the Fed, activities of our very own RBI, government policies, etc.

      You can read more on this topic in our articles on ‘Quarterly Earnings Announcements’ (click here) and ‘Law Of Supply & Demand’ (click here). Feel free to get in touch with in case of further queries.

      Happy Investing!