Is it the Right Time to Invest in Equities?

Posted by on May 20, 2016 in Financial Matters | 0 comments

‘Is it a good time to invest in the stock market?’ If you are an investor in the Indian equity market and either put money directly into equities or through a mutual fund, you’ll have to answer this question often for yourself of for your friends and relatives. Is there any single piece of statistics that can tell you how expensive or cheap the market is at any specific point in time?

For Indian investors, the easiest way to find out if it is a good time to invest is to compare the index level of either the Sensex or the Nifty to the earnings of all the index companies. This shows an investor how much he is paying for every rupee of earnings. This valuation metric is captured by the stock market Price to Earnings Ratio or PE and serves as an objective measure of how expensive or cheap the market is at any given point of time.

pen and wash drawing bengalitranslator.netMorningstar’s Guide to Winning in the Market

In the context of the Indian equity market, it has been observed historically that investments made when the Sensex PE is relatively low earned better returns while those made when the market valuation is high either earned meagre returns or ran into losses. By simply buying more of an index fund or a diversified equity mutual fund when the market valuation is low will thus help any layman investor to do well in the equity market. If there is a need to invest a certain amount of money at regular intervals, it is better to invest more in equities when the PE is low and more in debt when the PE is high. This is a far better strategy of investing in the equity markets than mechanically select a Systematic Investment Plan (SIP).

It is the dream of every investor in the stock market to buy low and sell high. One of the ways of doing that is to time your entry and exit based on the market valuation. The chart below would give you an idea of how the Sensex PE determined the returns investors received in the last 20 years.

sensex pe and returns

Source: The Economic Times

It is evident from the chart that your chances of earning a positive return from the equity market are much higher if you invest when the PE ratio is 18 or below. At the same time your chances of making losses as compared to other more secure investments like debt mutual funds or bank fixed deposits go up if you invest when the market PE ratio is 20 or more. It is not a very difficult task for an ordinary investor to keep track of the Sensex PE and invest accordingly either in equities or debt and perhaps to rebalance when the market goes way up or down.  

Don’t know where to find the Price to Earnings (PE) ratio of the Sensex or the Nifty? These can easily be tracked on the websites of the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE). Or else please follow the links below:

Nifty 50 as on date

Sensex as on date

You can also use IDFC Mutual Fund’s PE Ratio Scale to have an idea as to whether the Indian equity market is cheaply or expensively-priced and decide on whether you should put more money into equities at any given point of time.

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