What is a high index PE?

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When the markets start to move for a few days, investors tend to look at the index PE to check if the market is overvalued or not. Before we caution ourselves (and others) about ‘high PE’ levels, it would be quite instructive to pause and think about the historical evolution of the index PE .

Before we ask, what a high index PE is, we should be asking, what factors affect the PE of an index?

These are quite obvious, but it makes a difference to stop and think about it.

1. Each sector has its own definition of high and low PE.

2. Indices like the Sensex and the Nifty consist of stocks from different sectors. So the index PE is ‘some kind of’ weighted average of the sector PEs.

3. An index is only as good as its stocks. If there are marked changes in the composition of the index, the definitions of high and low PE will also change. On Aug  19th 1996, half the composition of the Sensex was changed in one-shot. This implies what a ‘high PE’ was up until then had to be thrown out of the window in one shot. (vertical line in the graph below).


4. Change is the only constant. Blue chips in the 80s found the going tough as liberalisation set in. Then came the rapid growth of the software giants, pharma companies and FMCGs. The composition of the Sensex has been changing over time. The future will be no different.

5. On April 20, 2000, Satyam Computer, Zee Telefims, Dr. Reddy’s Labs, and Reliance Petroleum replaced Indian Hotels, Tata Power, Tata Chemicals and IDBI. The PE shot up by 10 points immediately! (arrow above)

6. Now consider major events which led to sharp downturns: The Harshad Mehta Scandal – 23 April 1992. The dot-com crash in 2000, the sup-prime crisis in 2008. These were specific events which had nothing to do with market valuations. They could have occurred at any PE. If they had not occurred, or not occurred when they did,  we will never  know how high the market would have gone up.

7. I can think of at least two instances (green circles above) when the market came down from ‘high PE’ due to no specific event. Even here, the high PE in each case was different.

Some things to ponder

  1. Markets need not crash because the PE is ‘high’.
  2. Markets can crash at any time, for any number of reasons.
  3. The markets can hover around a ‘high’ PE for months, moving up and down.

Before you wish to adopt a PE-based investing strategy, I would invite you to read,

Relevance of the Nifty PE for the long-term investor

Misconceptions about the Nifty PE

Stare at the “long-term” moving averages of PE and other metrics using the

Nifty Valuation Analyzer: PE, PE, Div Yield, ROE, EPS Growth Rate

Ps. the NSE indices are toddlers. So don’t take these numbers too serious.

Conclusion: I repeat, change is the only constant. When the ground is shifting beneath our feet, it would be wise not to hang onto to rules based on past data about what is ‘high’ and what is ‘low’

Reference: Making sense of the Sensex

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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  1. Hello Pattusir,
    I have only one word to say “Amazing” Post, I have been under the misconception that whenever NIFTY P/E ratio is in the range of 22 -24 & above , markets crash.I have no shame in confirming that i was wrong
    Many thanks for posting such articles with facts and figures

  2. Hi Pattu Sir, very useful post…… I have been in the impression that 25+ means market is over valued. Now this article is questioning that assumption. I need to unlearn, taking some time to digest it.

    Btw, the dot-com crash in 2000, the sup-prime crisis in 2008 all had valuation running ahead of intrinsic value right? May be those incidents just triggered the market to question valuation and resulted in correction… so the fact that markets were over valued and corrected remains there right?.

  3. Whatever is written in the article/post, there cannot be any denial to the fact that whenever Sensex PE has crossed above 21/22, it has entered into ‘danger’ zone and therefore has corrected. Now there can be nth number of reasons which are explained why market has corrected. But the principal factor is that it has entered into ‘danger’ zone and therefore has to correct to its normal high level of less than 20.

  4. High PE is a relative term.A PE of 20 ia high when yield is 8% plus.But a PE of 25 is ok when yield is 5%.By yield i mean fixed income return.With interest rate in decline PE expansion is natural.So a low inflation can sustain high PE even if earning expansion is not as much.

  5. I think there is whole lot of confusion over here on what is ‘high’ PE and what is ‘low’ PE. Agreed all things in this world are relative only. Nothing exists in vacuum. Including correlation does not mean causation.
    What we are discussing is theories and its practical relevance in a given set of situation. I hope we all understand by ‘caeteris paribus’ – a fundamental dictum while giving any theory. Point here is that are there enough drawable conclusions based upon past market behaviour and how this learning can be applied in practical life. While talking about all these theories, risk free return is taken as base and that risk free return is GoI securities/bond yield on any given date. I agree that PE of 20 is OK/nearing high zone against risk free interest security yield at 8% and PE at 25 (OK/nearing high zone) against risk free interest security yield at say, 5%.

  6. “Point here is that are there enough drawable conclusions based upon past market behaviour and how this learning can be applied in practical life.”
    Past market behaviour does not say what is a high zone and what is a low. That is precisely the problem, Ceteris paribus, it is possible to prove this rigorously and I believe I have at least attempted to do so in the past.

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