Indian Stock Market: Keeping you out of trouble

As I was going through my archives of good articles on investing (value investing in particular), I came across this article by Prof. Bakshi which might throw a little insight into what we can expect in the markets at the current level.

Here’s the article –

http://www.sanjaybakshi.net/Sanjay_Bakshi/Articles_files/Keeping_you_out_of%20trouble.pdf

The important excerpt –

Resolution 1: You will avoid equities when they become historically expensive
Recent research done by my firm shows just how dangerous it is to remain invested in an expensive market. Since NSE started, every time when Nifty’s Price/Earnings ratio exceeded 22, the average return from Indian equities over the subsequent three years became negative — see accompanying table.

Nifty’s PE          Three year returns%

Less than 14            152.10%
14 –16                      112.36.%
16 – 18                     79.14%
18 – 20                     51.18%
20 – 22                     21.18%
22 – 24                    -14.98%
24 – 26                    -32.92%
26 – 28                    -36.60%
28 – 30                    -40.17%

You can look up the current P/E multiple of Nifty from NSE’s website — see http://www.nseindia.com/content/indices/ind_pepbyield.htm. As I write this, I notice that Nifty’s current P/E multiple is 13.49 and while you read this, you may wonder why am I warning you about expensive bull markets now? The reason is simple. You won’t listen to my advice in a bull market.

Every bull market produces large profits for investors which gives them a high. This euphoric feeling is identical in biological terms to the feeling a cocaine addict gets after consuming a few grams
of the substance. (Brain scans of addicts minutes after they get a shot of cocaine, and those of stock market investors who just made a large sum of money are identical.)

It just feels so good that no addict ever wants to stop the feeling of euphoria. It is exactly at this time, when addicts become suggestible. They believe almost anything that will allow them to continue experiencing euphoria. Walter Bagehot, the famous British essayist once said, “All people are most credulous when they are most happy.” He was right. When the next bull market comes, you will find plenty of “experts” who will tell you to buy stocks and to remain invested, and to ignore lessons from history because “this time its different.” You must resolve today that you will ignore such advise. You will avoid investing, and remaining invested in equities when they become historically expensive.Remember this: History tells us that when markets fall, almost every stock falls too. Sure there are cheap things to buy in a bull market. They are traps. You will avoid them because you know that cheap things will become cheaper after a major market decline.

By ignoring the table and my advice, you will not prove Benjamin Disraeli right when he wrote:
“What we learn from history, is that we don’t learn from history.

So, what are our latest Nifty P/E figures?

Date P/E P/B Div Yield
04-Feb-2011 20.67 3.40 1.15

(If you haven’t gone through this post before, you should right away!)

There are about 7 companies in the Sensex (and quite a few in the Nifty) who are yet to declare their Q3 results, including companies like Tata motors, Unitech, Tata Steel, M&M among others. Let’s assume that all these companies churn out good numbers (just like all others have). On that assumption, we can safely estimate that Nifty at these levels (Nifty is at 5395 as of today) Nifty P/E is 20, or slightly below 20.

Synthesizing the two data points, what do we derive? Prof. Sanjay Bakshi’s firm’s calculations indicate that Nifty P/E at 18-20 levels have average three year returns at 51.18%. Nifty P/E is at 20 (or slightly below that)

Is there a further chance of correction from here? (If Nifty does indeed go to, let’s say 5100 from here, Nifty P/E will be around 18.5). I have absolutely no clue whether it is going to go down or going to go up. However, are the odds in making a decent (not outsized) return in our favor from these levels? A little more correction and I certainly think the odds tilt in our favor. Of course, I don’t advocate a lumpsum investment in these volatile times (If the market corrects after a lumpsum investment, recouping the loss is much tougher. Check out this wonderful video by Deepak Shenoy which illustrates the logic). A SIP (or an increased SIP if you already have one) would put the momentum behind your returns.

Disclaimer: The view is on the broader market and not on any particular stock. Again, please do your own research before investing.

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