Misconceptions about the Nifty PE

Published on / By M. Pattabiraman Twitter: @pattufreefincal / 48 Comments

Published: November 25, 2014 at 7:00 am

Last Updated on August 7, 2016

Are the markets overvalued? Is the Nifty PE too high? Should I exit and re-enter later? Aided by  ‘experts’ who advice ‘caution’, such questions are doing the rounds again.  Here are some misconceptions and myths about the Nifty PE.

In a previous post on the relevance of the Nifty PE for the long-term investor, I had shown that exiting at high PE and re-entering at low PE does not guarantee loss-prevention or  large gains! The spread in possible returns is too high.

I wrote,  the case for not investing at high PE (~ 25) remains strong enough, whereas the case for investing only at low PE (< 15) has weakened, thanks to the wide range of returns possible.

Dumb me,  I missed the obvious corollary:

Build a complete financial plan with our Robo Advisory Tool. More than 1000 investors and financial advisors use it!
Get free money management solutions delivered to your mailbox! Subscribe to get posts via email! (Subscribers get exclusive discounts!)

New Tool! => Track your mutual funds and stocks investments with this Google Sheet!

If I exit at PE = 25, when do I enter? The answer is whenever!

So one could, and must argue, why exit in the first place if your goal is several years away?

Unfortunately, neither can we rely on past data (our market history is too short), nor can we invest without emotion. So  for someone with considerable net worth, it is not a terrible idea to reduce equity exposure at 25 PE.

There is the danger that after exit the markets may create history and keep moving up  but I think it is not such a terrible issue for a mature person.

With that out of the way, let us consider what Prof. Sanjay Bakshi writes in an article titled, “Keeping you out of trouble: your resolutions for 2009 and beyond”, he says

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%
I am afraid averages without considering standard deviation or the spread is of little use. To imply and to assume that the return was negative when PE exceeded 22, based on this result is baseless, at least for Nifty stocks.
Rolling returns offer better insight.
nifty-pe-myth-1
 The red dots refer to the PE when 3 year returns were negative if invested on that date.

Notice most of the data is centered around the dot-com crash. PE values from about 16 to 20 led to negative returns and not just 22.

Notice the small bunch of red points right in the middle of the so-called ‘bull run’. Related reading: Anatomy of a bull market

Then  we have some points just before the 2008 crash and some points in 2010 when PE was close to 25.

A negative 3 year return and a PE of 22 or above occurred only 42.7 times out of 100! The rest of the times, the negative returns came when PE was between 15 and 22! Please don’t bet that a high PE implies a low return …. at least over 3Y!

Notice the spread in returns possible corresponding to the PE on the date of investment. Current PE is close to 22. So the blue box tells you what to expect or rather what not to expect.

nifty-pe-myth-2

Now to 5 year returns. There is not enough negative returns data available. All points in that bunch correspond to a PE greater than or equal to 24.5.

Meaning, if you stay invested for 5 years, current PE most likely does not matter!

nifty-pe-myth-3

 Notice that the bunch (below) has not shifted to the right. Again the spread is too large.
nifty-pe-myth-4
You can see similar graphs for longer durations here: relevance of the Nifty PE for the long-term investor
Moral of the story: If you want to exit because the PE is ‘high’, please do not point to market history. Point to yourself.
Do share if you found this useful
Enjoy special discounts on our 10th anniversary until May 31st!  
Explore the site! Search among our 2000+ articles for information and insight!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
Use our Robo-advisory Excel Template for a start-to-finish financial plan! Now with a new demo video! ⇐ More than 1000 investors and advisors use this!
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 2800 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! ⇐ More than 675 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
My new book for kids: “Chinchu gets a superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both boy and girl version covers of Chinchu gets a superpower.
Most investor problems can be traced to a lack of informed decision making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, if we had to groom one ability in our children that is key not only to money management and investing but for any aspect of life, what would it be? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parent’s plan for it and teach him several key ideas of decision making and money management is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Did you know? We have more than 1000+ videos on YouTube to explore! Join our YouTube Community!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish mutual fund screeners and momentum, low volatility stock screeners .every month.
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps