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22 September 2009

Déjà vu : I've Been There

I don't know about you but for the past couple of weeks I have been having a sense of Déjà vu. A thought that something similar had happened earlier, has been gnawing at my bones. Though my head tells me that something as extreme as 2007 may not happen but then why take a chance? So I went about investigating further.

Index Valuation
The Nifty is currently at a PE of 22.41 with 74% of the Nifty constituents (by weight) trading above this mark i.e 31 stocks by count. The balance 19 companies are from the cement, metals, BFSI and PSU Oil& Gas spaces - all historically low double digit or single digit PE sectors. Suffice it to say that the index is trading close to the danger mark. Have a look at the graphic given below. Notice the PE 20 line. 

Without fundamentals following the rise above the 20 mark, the move could be termed as euphoric, with catastrophic results for the retail investor. The cliff face that you see there is Jan 08, wherein not many of us were able to move out of the market. If you wanna climb this mountain be well equipped.

Relative Valuation
Let us assume that the complete EPS of the index i.e the sum of the EPS of all 50 companies of the Nifty is distributed amongst the shareholders as dividend. Then the dividend yield (currently 1.02%) would become 4.46%. Remember, the future EPS has a certain amount of risk embedded with it.

Compare this to the risk free rate i.e the yield on the long term govt security or the 10 year Govt of India Bond which currently stands at 7.06%, a difference of -2.6%. So rather than getting compensated for taking enhanced risk in equities you are losing money and in a riskier asset. 

On 06 Mar 09 the Nifty touched a low of 2539 and a PE of 12.44 i.e an yield of 8.19%. The 10 yr bond had an yield of 5.78%, a difference of 2.41%. Need I say it was the right time to invest. (Of course hindsight is always 20:20!). 

Now have a look the graphic given below.


So the better period of investment in the Indian stock market is past, unless the bond yield goes down to about 5 % or the Nifty PE falls to a safer level say 13-14. Preferable both together! I would then plough my savings right in!!

However liquidity is a beast which may take the market to a higher level from here like Sep 07 to Jan 08. For fall in liquidity watch for two indicators - appreciation of the rupee and rise in interest rates.

So should I sell - maybe not but definitely get rid of the weaker suits, hold the trumps. 
Should I buy - I would hold on to that cash.




4 comments:

shaq said...

interesting and a different post...most blogs are comparing the p/e with same historical calculations etc...first article where there is some diff approach...thanks

Puneet said...

@ Shaq,
Thanks for your comment

Anonymous said...
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Epic Research said...

I read your blog consistently , really it's a good post and well describe  .

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