Nifty PE crosses 24|A statistically informed entry-exit model!

[valuestudent]

Here’s a few things to think about… experienced team members please do contribute with your learnings and experience.

1. Let’s go back in time and read what Prof. Sanjay Bakshi said about the NIFTY PE Ratio: http://fundooprofessor.blogspot.ae/2005/07/reflections-on-indian-stock-market.html

2. Lets see this chart which is available at Craytheon for 3 Year returns (based on the prof’s data) which shows returns based on the current PE multiple in the future (please use the link as I did not want to copy the image without permission) Nifty P/E Ratio, Price/Book Ratio, Dividend Yield Chart

Now, since the above links have one old musing (albeit among the most intelligent) and one technical chart which may not tell us about today, let’s look at some current data.

Current PE Ratio’s:

So lets get this clearly… The Nifty 500 is trading at a PE of 28. Which sounds crazy to me at-least.

Ok, for the courageous, here’s the next one…

Small caps indexes with a PE of 100? Hmm… when did we hear that last? Or maybe… “this time it’s different”

Now to the psychology part…

First a definition of “psychology” from Wikipedia.
Psychology is the science of behavior and mind, embracing all aspects of conscious and unconscious experience as well as thought.

We have been hammered with the below in our minds for behavior…

1. We have to be a buy and hold investor… with references to Warren Buffett and the likes.
2. Look at the 20-30 year chart… In the long run it works out… this conveniently excludes the logic of investing.
3. All big investors are always fully invested… yes for those with a net worth of a billion dollars it might be acceptable to do that… what do changu, mangu, yourself and myself do?

Bigger issue: We convince ourselves of bullshit…

I hold only 10-12 or 15-18 PE (define your range) stocks so this should not affect me… nonsense. when things will happen they will happen everywhere.

–
Now my thoughts and actions…

At these prices can I hold on expecting to find a greater fool? I think the final fools are standing close to the frontier… how far can foolishness go? only a fool with money will advise us.

I became 50% cash at the start of the month, and became 60% cash today. Maybe I am being stupid… I think better stupid that poor.

Do note I am still 40% invested.

What is driving this foolishness…

As the previous person Deepak who posted above… It seems like all bad news is shut out and good news makes rallies. That is true. The huge impending bankruptcy of some major companies as directed recently also barely had an effect.

If I may address the elephant in the room… are we discounting logic in the name of “one person who will change everything?” should we include changing our logical thinking in that?

Stocks can only rise for fundamental reasons… the fundamentals say, don’t be mental.

Now lets see the price multiple of a bellwether stock… Hindustan Lever.

It is a stock that has been known and recognized for a long time and even then it’s multiple has risen from average of lesser than 33 to 52? And everyone is behaving rationally?

I remember peter lynch had mentioned in one of his books that PE should be equal to growth so is it growing at 40 to 50% a year?

In all this we sometimes forget what we learnt when we came in… you make money in stocks when you buy low and sell high… then we forget to sell.

These are my thoughts anyway and I am sharing them with you… would appreciate comments laced with experience.

[sivaprakasamp]

Good post. Going by your own examples, PE is high. But PB is average. If you take small cap, PB is about 2x. As someone in this threat said, it simply implies ROE is low. So the key is will ROE increase. Compared to 2008 peaks, ROE is almost half. So companies have grown in scale but shrunk in profitability.

So the key question is, will profitability improve?

[valuestudent]

@sivaprakasamp I honestly don’t know, but I would question myself that is it better getting shot in the shoulder than in the head? yes, then it might be better
Basically, to me the simple answer seems to be making more sense but since I have little experience I am asking for opinions from our members who have seen much more than me.
I do know one line of thought which one of my friends mentioned recently, before a crash there will be a lot of froth… my question was… does there have to be? is it a rule? i will time the froth? then I sold.

[Lotus]

The story is a little more complicated than what the world has witnessed in the past. It is a story where the heros (central bankers) are turning to villans.

To understand the current situation, we need to look beyond India and look at
USA, Europe, Middle East and China.

“Pump and dump” have been practiced by local traders a decade ago; now, it
is practiced by countries (SIF - sovereign investment funds and central banks)

I can guess how this movie will end; not sure, what twist and turn it will take, and
how long the good times are going to last.

When it doubt, keep as for away as possible…

[SUNRAY]

@valuestudent

I hold only 10-12 or 15-18 PE (define your range) stocks so this should not affect me… nonsense. when things will happen they will happen everywhere.

Valuestudent,

Excellent post… Above quote is my fear for myself.

Is’nt buying low precisely this level of PE?

My concern is the same PE that is 15 today was 5 last year… Yes, I do see growth in sales, revenue etc. Can I not take a stand with these stocks?

[sivaprakasamp]

Agree guys, I stand corrected on the PB bit. I just did a recent screener and checked why PB was low. The low PB is mainly driven by banks. So if we take SBI, given that they recently declared losses, PE has shot up but PB is still very low.

Hence what we are seeing now is a systemic issue. If banks recover, then the data shows all sign of peaking.

Discl invested in Pokarna and no other stocks

[valuestudent]

Sir. Your logic makes sense. The answer will have to come from your own mind because you own that business with tremendous personal stakes. I have mapped my mind in that post. Maybe some coffee and quiet time for 5-6 hours?

[bheeshma]

Hi all

interesting discussion. There are three critical inputs to PE ratios. Risk free interest rate, the risk premium and growth rates. The risk free rate is 6.5% i think. Lets just say that the risk premium is 5%. Indian enterprise has grown by 7.1% in the latest gdp numbers. Lets say it will continue to do that for some years ahead.

These assumptions give you a PE of ~23 roughly where we are at right now.

Best
Bheeshma

[valuestudent]

@bheeshma

Lets say it will continue to do that for some years ahead.

Bheeshma Bhai. I really enjoy your posts, always, and thank you for taking the time to reply. You have been around for a long time. But could the above if we think really hard not be classified as “astrology” Assumption is another bias. Please don’t kick me for saying that. I am just conversing with a alternate view and I apologize in advance because I think we all need to really think things through right now and I am grateful for your response. Also, I am thinking, that even if growth is maintained as you rightly say, but are too much growth and profits not already factored in? Also, here Taleb’s book “fooled by randomness” comes to mind. The future could be alternate, could it not.

Then lets visit Howard Marks. What has higher probability? What everyone knows? Growth, GDP, Inflows? GST? Good Governance? Then what will have an impact? Maybe what we don’t know?

I know I am probably wrong and you are probably right, but here’s one more thought; I am always looking out for Mr. Market. Some data below:

Headlines I have read in the last 2 weeks or so, all in June 2017!

first one… 150 Stocks make new lifetime high
second one… 100 stocks make new lifetime high
third one… 70 or 80 stocks make new lifetime high

What do the above remind us of? An impending boom? Or more like the tech bust and 2007-2008 bust? We have to think hard, really hard.

Apart from that, the indexes making new lifetime highs every few days has become like normal news. We don’t even seem to pay much attention to it anymore. It’s like… ah ok. next article.

Very humbly.

Best Regards.

K

[Mridul]

Past matters but to a certain extent. As someone pointed in this thread earlier, we need to see market valuation based on potential returns from various asset classes. Interest rates are going down, so your fixed deposits is barely beating inflation. Real estate is not going to give decent returns going fwd, gold is a passive play at best and will again barely beat other asset classes if at all. We are left with equity! The current rally has two legs …one - global rally, two - mf money coming from various asset classes into equity. India story in my opinion is just beginning. Valuation are high obviously, but we also need to see this with respect to potential growth prospects…rising middle class and the related consumption story will gradually play out resulting in keeping these valuations stretched. These might be the new normal, as not many other economies are growing as rapidly as us. This is and will be a major factor defining valuations in future. Corrections will happen, but i don’t think we will see nifty pe going down below 21-22 anytime soon.

[valuestudent]

Anything is possible

[Mridul]

Yes, but we need to see the probability and possibility of the event. Otherwise there is no point discussing if one says “Anything is possible”. Well… of course, yes!

[valuestudent]

Ok. Here you go. Now don’t you come kicking me

We are left with equity! - First sign of Mr. Market

Real estate is not going to give decent returns going fwd - astrology (prediction)

The current rally has two legs …one - global rally, two - mf money coming from various asset classes into equity - Money that we do not control and cannot ask it to stay.

Rising middle class and the related consumption story will gradually play out - I agree. But we are not benefiting by the growth. We benefit by paying low for it. It is not only priced to perfection; it is overpriced.

i don’t think we will see nifty pe going down below 21-22 anytime soon - astrology (prediction)

These might be the new normal - Final thoughts of Mr. Market before it plunges to it’s death.

Don’t kick me. I told you in advance.

[gautham1]

Very interesting topic. I am surprised there is not much participation here. I am in the same dilemma. (in fact not comfortable with the valuation). If you read the interviews, you will see all sorts of justification for high valuation like low interest rate, worst is behind, trailing pe is misleading, capability utilization, operating leverage, good monsoon, gst, indian economy, inflection point etc etc.
Coming back to the topic, one can say we should sell/trim down on over valuation. But trust me it is very difficult to build a portfolio all over again. ( even the partial sell. let alone a complete portfolio selloff) I want to hear from the others in forum. ( with a reasonably big portfolio) on how to handle such a situation. Do you guys keep invested all the time regardless of the valuation?. We dont get to hear on these strategies.

[josephseby]

This post includes some targets for sensex. I am not sure whether I am violating any rules of valuepikr that one should not give any targets for the stocks discussed. Just sharing an interesting information got from a site. Its about grand cycle in global markets. its says about an 18 year cycle with two parts 14+4. 14 years of bull market and followed by 4 years off deep correction and recovery. Then starts the next cycle. I did a study with the sensex charts from 1979(as it is only available from1979). I am attaching my studies and also giving the links from where i got these informations.https://pro.southbankresearch.com/p/CTC-1116-14foura/WCTCT601/?h=true.This one from elliot wave internationalsensex 1979 charts.xlsx (113.6 KB)

[valuestudent]

@gautham1 You have touched on what are the two most difficult things to do
Build conviction to buy and then to hold (which is so difficult)
Build conviction to sell (equally difficult) full or partial

First, lol on the “inflection point”. I think I will puke if I hear it anymore

I will share an advise I once got from a elderly investor. I asked him on booking profits and he said “I have never done it and just held it though everything… but many of my friends had a habit of booking around 20% of the profit at every year or two if the prices had quickly risen by 30 to 40% and then would plough it back when it had corrected by around 20% and they have done better than me”. So his friends knew that they could not use the money for anything else and could only use it to buy back with the exact amount withdrawn into the same company. It does require the utmost patience and knowledge of those stocks and their characteristics and behavior, plus heaps of market experience. Plus they are never out of their portfolio over 20%

Maybe you could touch upon some of the more experienced investors you know and a collation of opinions from 2-3 of them would be pretty cool. Even I would love to hear and learn. As I had read somewhere “There are old investors, there are bold investors, but there are no old and bold investors”.

He and his friends are mainly invested in the HUL / Gillette type of stocks.

[bheeshma]

The best way to gauge is to draw a major upward sloping trendline on the broad index and see whether its broken or not. Till such time the main trend remains intact the party continues. Trendlines on the main index help you to remain rational. High PE low PE are all best left to academics.200/50 day mov avgs are also very useful to gauge sentiment.

[valuestudent]

An explanation of market bubbles that doesn’t blame greed or incompetence, and a strategy to protect yourself from their inevitability.

http://www.collaborativefund.com/uploads/Collaborative%20Fund%20Bubbles.pdf

[Yogesh_s]

PE ratio of HDFC Bank is also a good measure of overall market valuation. Here is the chart.

I know that PE ratio of a single stock is not the same as PE ratio of 50 stock index but this is the largest component of the index, most popular stock of DII & FII, part of a large number of mutual funds, has consistent growth record spanning 2 decades and has a high floating market cap. Its beta and standard deviation is also close to Nifty 50. There is no adjustment or ambiguity in calculation of its PE ratio or growth rates as compared to Nifty 50.

Looking at the charts above, HDFC bank is trading at a 5 year high PE ratio while its growth has moderated from 25%+ to sub 20%.

Table below shows some statistics

Price has grown faster than all the fundamental indicators like earnings and book value.

[valuestudent]

@Yogesh_s Yogesh Sir. Thank you. We really need the assistance of seniors like yourself to remember to keep our sanity when it’s needed. Your charts (pictures) speak a thousand words. Please help us further. And if the reclusive (pun intended) @Donald @hitesh2710 @ayushmit can also comment with whatever their feelings, we will have a good time learning. Nowadays, they are only asked for stock advise Seniors, can you roll your sleeves and give us your mind maps