When is a good time to invest?
P/E = price to earnings ratio
A lot of investors use this term because P/E is by far the most popular valuation method used by investors and analysts to understand whether particular stock is cheap or expensive.
So, p/e will tell you if particular stock is cheap or expensive. It is calculated by dividing stock price by company’s earnings per share (EPS).
So, P/E = price/EPS,
Where EPS= net profit/no. of shares outstanding
EXAMPLE
If company’s stock price is 120 and EPS is 10 then,
P/E = 120/10 = 12
If same stock moves up to 150rs assuming stock price rises 120 to 150 while earnings of company (EPS) remains same at 10, then
P/E = 150/10 = 15
As a general rule of thumb, “ Higher the p/e, more expensive the stock.”
This is because investors are paying more for each rupees of company’s earnings.
Now like stock has a p/e, whether it is cheap or expensive, the stock market also has it’s p/e.
So stock market, assuming we are also looking at BSE-SENSEX which represents market also has its p/e, like a stock.
A stock market p/e tells us whether broader market is cheap or expensive. So like INFY is trading at p/e of 16.9, the Bse-Sensex has p/e of 18.77
Now you may wonder, looking at INFY’s p/e, I can tell whether the market is cheap or expensive relative to other stocks and sectors but how do I know whether all over market is cheap or expensive looking at sensex p/e.
After all, sensex is not single company but it is made above 30 companies.
So Question is at what sensex p/e should you earn good long term return?
Well the answer is here,
P/E 3yr Return
>19 2.6%
16-19 15%
<16 21%
A lot of investors use this term because P/E is by far the most popular valuation method used by investors and analysts to understand whether particular stock is cheap or expensive.
So, p/e will tell you if particular stock is cheap or expensive. It is calculated by dividing stock price by company’s earnings per share (EPS).
So, P/E = price/EPS,
Where EPS= net profit/no. of shares outstanding
EXAMPLE
If company’s stock price is 120 and EPS is 10 then,
P/E = 120/10 = 12
If same stock moves up to 150rs assuming stock price rises 120 to 150 while earnings of company (EPS) remains same at 10, then
P/E = 150/10 = 15
As a general rule of thumb, “ Higher the p/e, more expensive the stock.”
This is because investors are paying more for each rupees of company’s earnings.
Now like stock has a p/e, whether it is cheap or expensive, the stock market also has it’s p/e.
So stock market, assuming we are also looking at BSE-SENSEX which represents market also has its p/e, like a stock.
A stock market p/e tells us whether broader market is cheap or expensive. So like INFY is trading at p/e of 16.9, the Bse-Sensex has p/e of 18.77
Now you may wonder, looking at INFY’s p/e, I can tell whether the market is cheap or expensive relative to other stocks and sectors but how do I know whether all over market is cheap or expensive looking at sensex p/e.
After all, sensex is not single company but it is made above 30 companies.
So Question is at what sensex p/e should you earn good long term return?
Well the answer is here,
P/E 3yr Return
>19 2.6%
16-19 15%
<16 21%
NOTE: Average 3 year returns calculated daily for days when sensex p/e was>19(red), between 16-19(yellow) and <16(green). Days which do not hace 3yr forward returns have not been considered.
Above table shows 3yr returns calculated daily for days when sensec p/e has been at different levels.
While we are not saying that past performance will surely repeat in future, we are just trying to indicate what has happened in the past and how much returns investors have made by investing at different levels of sensex p/e.
So if history is any guide, it pays to invest when sensex p/e is <16 as it indicates a conducive environment for long term investing and there has been several periods when this has been true. That is sensex p/e has fallen below 16 only to recover and earned investors good long term returns.
Above table shows 3yr returns calculated daily for days when sensec p/e has been at different levels.
While we are not saying that past performance will surely repeat in future, we are just trying to indicate what has happened in the past and how much returns investors have made by investing at different levels of sensex p/e.
So if history is any guide, it pays to invest when sensex p/e is <16 as it indicates a conducive environment for long term investing and there has been several periods when this has been true. That is sensex p/e has fallen below 16 only to recover and earned investors good long term returns.
This chart shows Nifty’s and sensex’s performances at different p/e levels. Green dot in nifty chart and or green horizontal line in sensex chart shows the time period when nifty and sensex were trading below 16 p/e. so you have several periods of past history when both indexes were trading below 16 p/e and investors, if they have invested, would have earned good long term return from market and latest we had such situation in 2012 and we know how investors invested during that period of 2012 have made money in stocks and mutual funds.
Now it is easy to see charts and promise to yourself that I will definitely buy stocks or mutual funds when nifty or sensex p/e falls below 16 next time.
But wait before you get excited and promise yourself this because if history is any guide to show us how investors behave when stock price are falling and valuations are attractive, you may be surprised.
In past, even though market p/e was below 16, the net inflow of money was negative by 2% or should we say -2% and when p/e was over 20, investors have invested 71% of money. Ironically, isn’t it?
These means that investors have sold more stocks then they have bought when stock prices were cheap. What is more, these investors have bought most amount of stocks when market p/e was grater then 20.
We know it is difficult to be an investor in stock market when everyone around you is selling stocks. But then this is what separates sensible and successful investors from others.
Only who go against the crowd and buy stocks when there is a fear all around and stock valuations are attractive can make money in long term.
As legendary investor Warren Buffet says, “Be fearful when others are greedy and be greedy when others are fearful.” We hope you will be.
Happy investing.
Now it is easy to see charts and promise to yourself that I will definitely buy stocks or mutual funds when nifty or sensex p/e falls below 16 next time.
But wait before you get excited and promise yourself this because if history is any guide to show us how investors behave when stock price are falling and valuations are attractive, you may be surprised.
In past, even though market p/e was below 16, the net inflow of money was negative by 2% or should we say -2% and when p/e was over 20, investors have invested 71% of money. Ironically, isn’t it?
These means that investors have sold more stocks then they have bought when stock prices were cheap. What is more, these investors have bought most amount of stocks when market p/e was grater then 20.
We know it is difficult to be an investor in stock market when everyone around you is selling stocks. But then this is what separates sensible and successful investors from others.
Only who go against the crowd and buy stocks when there is a fear all around and stock valuations are attractive can make money in long term.
As legendary investor Warren Buffet says, “Be fearful when others are greedy and be greedy when others are fearful.” We hope you will be.
Happy investing.