This article investigates the price to earnings multiple of S&P CNX Nifty from January 1999 to May 2006. It also examines the fundamental drivers of the price to earnings multiple and given the current fundamentals and multiple what the investors can reasonably expect.
After
the spectacular rise in the stock market over the last few
years, the market now seems to be experiencing extreme volatility
and market participants are wondering as to where the market
is headed for. We hear of several reasons like FIIs withdrawing
funds due to expected Fed rate hike, profit booking due
to premium valuations of our markets compared to our peers,
selling pressure to meet the margin requirement of the clearing
corporation and so on. Anomalies do crop up, markets can
get irrationally optimistic, and often attract some unwary
investors. It is hard to avoid the temptation to throw one's
money on short and get rich quick speculative binges. The
consistent losers are the ones who get swept away by these
temptations. So, how does one go about safeguarding one's
investments?
Although
one can never judge the exact intrinsic value of a stock,
one could roughly gauge when a stock seems to be reasonably
priced. The market price-earnings multiple is a good parameter
to start with. The Price to Earnings Ratio (P/E) is the
most widely used measure to know the cheapness or richness
of an equity investment. Market multiples above historical
norms will inevitably lead to warnings in the financial
press of a coming correction.
In
this article we try to study the behavior of P/E multiple
(of the market index S&P CNX Nifty) during the period
of January 1999 to May 2006 and subsequent short-term returns
if invested at different price to earning levels. Next,
we take up the fundamental drivers of the P/E multiple and
given the fundamentals, what investors can expect reasonably. |
