At the current PE of 19.52, Nifty is at its cheapest since 2014. The long term mean PE of Nifty is 19.95 and we are just a tad bit below those levels.
Over the last 4 years, the markets have traded at premium valuations. Trading at such valuations, in the hope of higher earnings growth, for such a long time made the investors think that 22+ PE was the new norm. Fund managers justified it citing forward Nifty PE ratios. We have been through a period of subdued earnings growth due to multiple factors and the growth has always been on the horizon, but it never came. Nifty’s earnings are growing at ~ 9% and they have been below 10% for the last 4 years. Once again it has been proven that investing at higher PEs can give negative to low returns for few years.
Looking at other ratios
On the price-to-book ratio, the market is well below its long-term average. While the mean PB Ratio is 3.5, the market is trading at a PB Ratio of just 2.47 now. Although, the return on equity of the Nifty is at ~ 12.65%, well below the cost of capital in India that is 14%. A lower ROE results in a lower price to book ratio paid by the market.
While the low EPS growth rate has depressed the earnings part of the PE ratio, making it seem still above the long-term mean, there are indicators which show that the market is cheap and ripe for long term investments.
|M.Cap to GDP||58%||78%||Cheap|
The market cap to GDP ratio is at 58% today and in the past from such levels the markets have delivered a CAGR of ~ 15% over 3 years. However, how much will the markets deliver over the next 3-5 years really depends on earnings growth. Forecasting the next year’s NIFTY EPS is like shooting an arrow in the dark. But we can develop an expectation of earnings growth over the next 5 years.
How fast will earnings grow?
The corporate profit to GDP ratio is at ~ 3.5% which is below the mean of 4.2%. At the time of the 2008 meltdown, the ratio was at ~ 7.1%. On this parameter too, we are not trading at expensive valuations and eventually this ratio will revert back to its mean.
Assuming an average GDP growth rate of 6.5% and inflation of 5%, we get a nominal GDP growth of 11.5%. With a corporate profit to GDP ratio of ~ 4%, we get an earnings growth of 15% to 16%.
Impact of Covid-19
It is impossible to predict when the world will be back on its feet. Will a 21 day lockdown be sufficient or will it be extended? Will there be normal business after the lockdown or will there be a long travel ban and partial resumption of business? The world will never be the same again, and the Indian markets will be affected too. The Government will have to let go of its fiscal discipline and provide a stimulus package to rescue the economy. In the financial crisis of 2008, the Government had provided a package that was 3.5% of the GDP and we reckon that this time it could be well above that figure.
Is this a good time to invest?
If the situation gets grim, Nifty might also touch PE levels of < 15. In 2003 and 2008, the Nifty traded at PE levels of < 12. However, it is a good time to invest for the next 5 years. While you may not see positive returns for the next 12-18 months but a historical analysis of PE levels shows that it indeed is a good time to invest.
If you have invested in 2017, you probably are in negative returns or at the best, low single digit returns now. However, don’t lose hope. Investing in equities for the long term WILL be a test of patience and conviction. Investing at PE levels of 22+ can require 5 years to see any decent returns.
Be fearful when others are greedy and be greedy when others are fearful – Warren Buffet
We advise investors to increase their investments if possible. If you have cash in your portfolio, you can consider systematically deploying it in equities. You must review your equity portfolio diligently because stocks that performed well in the previous bull run may not necessarily be the leaders of the new bull market.
If you are making SIPs, then continue your SIPs. However, it is advisable to review your mutual funds portfolio for the funds. We advise against having thematic funds in your portfolio if you are a passive investor.