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Price to Earnings Ratio & FOMO - Part I

 

Currently where the economic indicators are signaling negative numbers, on the other hand the share market has recovered and the precious metals like gold and silver are in uptrend. So where to invest and how much? Also, what does FOMO mean? If you wish to know all this, then let us find it out in our today’s blog.

 

The RBI Governor Mr. Shaktikanta Das has warned regarding an increase in the number of bad loans in the near future. Where the economic indicators are signaling negative numbers, the share markets have seemed to recover from the March’s low. It seems like the bull has no idea how it reached the high. The American-British Investor Sir John Templeton says that in the long-run, the Index follows the trend of the companies that it consists of.

 

Based upon the earnings, how to figure out if the Index is expensive or not? We can adjudge that based upon the Price Earnings Ratio. Now be it the year 2000, 2008, or 2019-20 whenever this Nifty PE ratio has crossed the mark of 27, the market has witnessed a fall. Currently, the Nifty PE ratio is around 29. That means for every Rs. 29 we pay, we earn Re. 1. So here the earning yield is around 3%. When compared with Banks, it is very less. This suggests that currently the market is at an expensive valuation.

 

If we observe the history, we’ll find that the market has moved in the range of 10 and 30. And whenever the common investor has invested at the time if higher market valuation and later when the market has fallen, he has had to face a huge loss. Despite the market valuation being expensive, hoe does the common investor invest here? He invests here because of FOMO.

 

Now what does this FOMO mean? It means Fear of Missing Out.  Now what does that mean? The common investor witnesses the increasing prices, so he thinks about the profit he will earn if he invests here. As he doesn’t wish to lose this opportunity, he resorts to investing here because of having the fear of missing out. Here, the common investor only observes the increasing prices but he overlooks the market valuation and due to that he is exposed to higher loss or faces huge loss later.

 

Now many investors who know the history of the Index valuation and despite of that how do they commit the mistake of investing there? In the year 2004, Mr. Warren Buffet quoted, “What do we learn from history? We learn the fact that people learn nothing from the history.” Also, the American – British Investor has quoted that, the four most dangerous words in investing are “This time it’s different.” Hence, the investors who know the history of the Index valuation and despite that they invest because they think this time it will be different. But it is a proven fact that history repeats itself and majority of the times, the market falls from a higher valuation.

 

Now be it the year 2000 or 2008 or 2019 or 2020, whenever the Nifty PE ratio crossed the mark of 28, the market witnessed a fall. But every time the Nifty PE ratio crossed the mark of 28, the value of Nifty has been different i.e. in 2000 it was 1818, in 2008 it was 6357, in 2019 it was 12,103 and in 2020 it was 12,430. Try to understand this carefully. Now while calculating the Price Earnings ratio, we divide the Price by the Earnings. In January 2008, when Nifty was at 6,357 the PE was at 27.28, so market had reached a higher valuation and after that it witnessed a fall. Later till October 2010, market moved slightly in uptrend and the PE ratio has crossed the mark of 25 due to which market had become a bit expensive.

 

So from January 2008 till October 2010, the top 50 companies in Nifty had not witnessed a significant increase in their earnings. Later again the market witnessed a fall and then from October 2010 till the year 2014, the market moved in a limited range. But during this time the top 50 companies in Nifty had witnessed a significant rise in their earnings. And at that time when Nifty was divided by that earnings i.e. 6336 / 361 equal 17.55 = PE ratio. Thus, that means the market according to valuation had become moderate. Hence, you need to check valuation along with the price 

 

Now whenever the market is at a higher valuation, the chances of a market fall are higher. For the market valuation to come down either the price need to fall down or the earnings are supposed to increase. Currently, the share market is at a higher valuation and Gold and Silver are witnessing an uptrend.

 

So then how should one construct his or her portfolio, find out in our next blog...

 

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