One of the most interesting strategies that I have come across is an investing strategy based on Nifty valuations. Valuations parameters we all understand – P/E, P/B and Dividend Yield.
I had read about investing strategy based on a single Nifty parameter, namely P/E. However, Momentum Signal had done a post a while ago (in Feb 2010) which included three parameters P/E, P/B and Div. Yield. I don’t see a reason why I need to repeat the entire analysis again except for linking to the relevant post here –
Nifty Fundas – http://momentumsignal.blogspot.com/p/nifty-fundas.html
The summary of that post is given below –
|S&P Nifty Index||P/E ratio||P/B ratio||Div Yield%|
|Extreme High Valuations||25 to 28||5.5 to 7.0||0.5 to 0.8|
|Very High Valuations||23 to 25||4.5 to 5.5||0.8 to 1.0|
|High Valuations||21 to 23||4.0 to 4.5||1.0 to 1.25|
|Long term Average||17.87||3.7||1.52|
|Low Valuations||15 to 17||3.0 to 3.5||1.75 to 2.0|
|Very Low Valuations||13 to 15||2.5 to 3.0||2.0 to 3.0|
|Extreme Low Valuations||11 to 13||2.0 to 2.5||3.0 to 3.5|
The table (the blogpost is more illustrative with graphs) indicates when valuations might be rich and when valuations might be cheap depending on Nifty’s P/E, P/B and Div. Yield ratio.
Essentially, valuations are rich whenever Nifty P/E > 20 and/or Nifty P/B > 4 and/or Nifty Div. Yield% < 1.
So, what are the current figures based on some recent corrections in the market?
NSE data suggests (Nifty at 5654) –
Correlating the data between the two tables, we derive that Nifty is richly valued in terms of P/E, not so much on P/B and very close to rich valuations on Dividend Yield.
My personal read into the situation, on a consolidated basis is that even after the recent correction, Nifty is richly valued and I would be wary of investing (except in few pockets) at current levels too.
When I hear analysts and CNBC talking about Sensex levels at 25k in 2011, 40k sometime in the future etc etc., I try to calculate what kind of earnings Corporate India needs to come up with to justify such levels of Sensex. The percentage increase is staggering (even considering Analyst’s speak of India’s GDP growth is 10% and will be 10% for the foreseeable future). Even if India’s GDP growth is at those levels, a EPS growth of 40% y-o-y is remote and hence Sensex at those levels in 2011/2012 look distant (unless of course, the market goes really irrational like the 1999-2000 boom).