Dec 20, 2012|
To outperform, buy cheap!
A few days ago, fund manager Prashant Jain appeared on a business channel discussing why retail investors - more often than not - lose out while investing in equity markets. His argument was simple. Retail level interest rises only when the markets rise; thereby, leading them to buy into stocks at expensive valuations. According to Mr. Jain, nearly 80 to 85% of the money (of retail investors) invested in mutual funds comes in at Price to Earnings Ratio (PEs) in excess of 17 to 18 times. In fact, retail investors are believed not to really put in money when the markets are lower or trading at lower PEs.
While investing in markets at peak levels (and high valuations) is one thing that investors should avoid, the ultimate aim for any investor is to outperform the benchmark indices by a healthy margin. As such, an underperformance to the benchmark over a long period should not be desired. Over the last two decades, the BSE-Sensex has risen at a compounded rate of 11.2%. Therefore, any returns below this level - on a compounded basis - would be considered as 'underperforming the benchmark index'.
And this was essentially Mr. Jain's argument! For investors to outperform the markets over the long term, it is important for them to invest in times when the markets are cheap. This would eventually lead them to see good returns as opposed to burning their fingers or being disappointed by the returns due to investing at high valuations. In the interview, he termed PE ratios of below 17 to 18 times earnings (long term Sensex averages) to be reasonable levels to enter the markets - albeit keeping a long term picture in mind.
We will try to see the difference between the returns investors could generate at two levels - above and below the long term average PE ratio.
We have excluded the extreme 10% PE levels (or high and low valuations) of the BSE-Sensex over the past two decades. On the balance data, the average Sensex PE came at about 18.7 times over this two decade period.
|Data Source: ACE Equity|
The chart above displays the Sensex's movement and PEs after excluding the extreme 10% levels as well as the average PE ratio of the index over this period.
We sorted the data as per PE ratio after that. We thus had different dates with data on individual date Sensex closing level and PE. We then calculated the compounded (depending on the date of the PE Ratio) returns from the Sensex closing on each date till the Sensex's closing levels as of 17th December 2012 i.e. last Monday. The data so compiled could be sorted into two broad categories. The 1st was the returns generated when Sensex PE was below the average PE. The average of the compounded returns of this group stood at 15.2%.
On the other hand, the average of the returns when invested at levels above the average PE ratio of 18.7 times stood at a relatively miniscule 7.2%. That is a difference of 8% per annum on a compounded basis. And if one would know about the power of compounding, he would know how much of a difference a small amount like 8% could make on one's portfolio returns.
As you would know, timing the market is a very difficult task and one that cannot be done to perfection. However, one thing that all investors can control is the valuations at which they invest into stocks. Going by the long term data displayed above, buying cheap does provide better returns.
||Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
Aug 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
Aug 18, 2017
Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.
Aug 17, 2017
PersonalFN simplifies the mutual fund account statement for you.
More Views on News
Aug 7, 2017
The data tells us quite a different story from the one the government is trying to project.
Aug 10, 2017
Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.
Aug 8, 2017
Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 7, 2017
Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407