P/E Ratio has been one of the most widely tracked form of valuation for many decades. Some of the modern day analyst do argue about its accuracy in predicting market movement and have shifted to more complex valuation methods. However, for our own markets, we have found historical P/E to be one of the better valuation methods available. Incidentally, anyone tracking the historical P/E would have benefited a great deal in terms of returns by successfully timing the markets before a major move occurs.
Historically, P/E of S&P CNX Nifty has fluctuated between 10 & 28. A good timing tool for the markets would be to enter when the historical P/E moves below 15 and to exit once it starts to move above 25. In the past decade, there have been two major tops and bottoms in the market. First market top was after the 1999 stock market rally which ended after the dot com bubble and the second market top was in 2008 when the sub prime crisis occurred. During both these occasions, historical P/E of Nifty was at 25 + levels. Similarly, there were two major bottoms; one after the dot com bubble when historical P/E began to trade under 14 and the second one after 2008 bubble when the P/E was under 13. In the figure below, values of historical P/E and the closing price of Nifty are plotted. One can easily map out the top’s and bottoms of historical P/E with the tops and bottoms in Nifty.
Nifty Historical PE Ratio
Historical Closing price of Nifty
In order to determine the statistical validity of the same, we ran a correlation test between the Closing price of Nifty and its Historical P/E over a period of ten years. We got a positive correlation of 0.7 on the same. This means, Nifty has effectively risen whenever the P/E’s have expanded and has steadily fallen when the P/E’s have contracted. Since Nifty is largely a function of where the historic P/E lies, it becomes relatively easier to project the levels of the same based on the forward earnings projections over the next quarters. Most of the time, retail investors do not have access to forward earnings estimates and hence for them, historical P/E is the benchmark to watch.
Nifty & PE Contour Plot
Periodically, historical P/E has corrected to levels of 15 – 16 every two to three years. Last time the historical P/E traded at these levels was back in October 2008. Since then, Nifty has risen from 2300 – 6200 with its historical P/E expanding from 15 – 25. Nifty recently (November 2010) made a intermediate top at 6200. Back then, the P/E was trading at 25. Since then, markets have fallen to 5200 and have risen back to 5900. Currently, Nifty is trading at 5565 with its P/E at 20.6. Over the period of 2 years, Nifty P/E has taken support around levels of 20 and going by this it may rally from these levels. However, one must keep this in mind that historical P/E of Nifty has not corrected for a period of 2.5 years now. Going by historical measures, it is due for correction and if that happens, it will retrace back to 15-16 band.
We are bearish on the market because of the same underlying reason. It is possible that P/E takes support here and markets indeed rally to new intermediate high’s. But eventually, markets will come down as the earnings need to consolidate before the next move happens. The best strategy currently is to be an active trader within the markets. In this way, you will ensure your participation in any kind of movement. The odds are definitely stacked towards the down side. But, our opinion has to be endorsed by the markets. Keep stops tight and trade safely.
Hi Raunak
Thanks to bring up the subject. Quit interesting to see how it has worked in your market in the past. What about the currency pair : Ruppe and USDollar ?
Black Panther
Seems like we will correct from here. At least probability is more towards correction.
Dear Dan,
Will look into it.
Thanks for the suggestion.
Tc
Rahul,
Probability is definitely on the higher side for markets to correct. However, don’t get too caught up with this opinion. Let’s see what happens.
Tc
hello
from where to get the pe charts with all studies
Zubair,
We can get the data at http://www.nseindia.com
In the indices section, select statistics.
Tc
Wonderful work. Market has exactly done this. Another couple of hundred points and Nifty PE would be 16.
Simple but effective. Great !
Excellent artcle. thanx for such a great analysis. every bit of it is correct.
@Ram thanks for your wonderful comments.