Sensex & Nifty are creating new all time record high every day. Market is optimistic & mood is euphoric. While many people have a reason to rejoice this bull run, there are a bunch of folks who are very worried & confused about if this is a time to invest more or sell more or do nothing? At AI, we have been receiving a lot of such queries about our view on current market condition, so here is our view.
To understand if market is overvalued or undervalued, there are a few parameters that are generally considered, P/E ratio & P/B ratio.
P/E Ratio: This ratio tells us how much we are willing to Pay per rupee of Earning. So, if P/E is 20, it simply means we are willing to pay ₹20 per share for every rupee in earning per share. If we take past 7 years data, the average P/E is around 19 & current P/E ratio of sensex is 22.57 (on 6th Jun). From this data, it seems market is overvalued by 19%.
P/B Ratio: Another widely used parameter is P/B which tells you Price per share vs Book value per share. Book value represents a company’s worth, if it has to be sold today. Last 7 years average for P/B stands at 3.0, currently P/B is 2.93 (on 6th Jun). From this data, market seems undervalued by 3%
Well, the truth is market being overvalued or undervalued are relative terms. There is always a baseline against which it is analysed. AI believes market is currently fairly valued, neither under nor over valued. While P/E ratio is higher primarily because of excess liquidity in the market, of late there has been a sea of money hitting stock market because of:
a) Foreign investors having access to cheaper money (Quantitative Ease of USA/Japan/Europe)
b) India retail investors started investing in equities since real estate & gold have been on a decline
c) Recent changes in EPF & NPS, pumping more money into the market
With respect to these factors, market average is bound to go higher & if we do our analysis based on historical data, it will look overvalued. P/E has been on rise also because of depressed earnings from Indian companies. We believe earnings should start recovering starting Q2 ’17.
This will give you an idea of current stock market valuations but does it really provide an insight whether to buy/sell or hold a stock? The answer is NO. If you are considering to take action based on market sentiments, it is not advisable. Market data is based on just 30 or 50 stocks which you may not be owning at all. Even in today’s market, our Multicap Multibagger portfolio is still at P/E of 14!
To draw an analogy, assume you are the principal of a school. As principal, you are trying to estimate class III results based on results of class X & XII. Will it give you correct estimate? The environment is same for everyone & facility is same, but students are different, each student or a class has unique characteristics.
So next time, you are bothered about market being over or under valued, remind yourself of this analogy & analyse individual stock’s P/E, P/B ratio & your investment thesis, do they stack up together & remain firm? If answer is yes, then you can ignore market noise and focus on your portfolio rather than index. This is where good & great investors are distinguished. If you have a sound investment process, then stick to it. Generally, it is not easy to follow stock market in normal course of life, in that case outsource it to someone like us. So that you can focus on your job & we focus on our job.
PS: For all new joiners, here is your free stock report