Nifty Price to Earnings Ratio or P/E ratio works same as P/E ratio of individual stocks. It measures the average P/E ratio of the Nifty 50 companies.
It is one of the simple but very helpful buy/sell indicator for all investors who believe in buying good companies at throwaway prices.
Nifty is considered to be in the overbought zone when Nifty P/E is trading at or above 22 and anything below 14 is considered to be undervalued.
Professor Sanjay Bakshi, a renowned value investor, said-
Recent research done by my ﬁrm shows just how dangerous it is to remain invested in an expensive market. Since NSE started, every time when Nifty’s Price/Earnings ratio exceeded 22, the average return from Indian equities over the subsequent three years became negative
Ideally, long-term investors who believe in value investing usually buy stocks when P/E reaches 14 or below and avoid buying when P/E goes above 22.
The table below gives a brief idea about the P/E based valuation.
Nifty P/E ratio on 08-10-2015 is trading at 22.71 where Nifty closed at 8129.35.
Currently, the market is trading at an extremely overbought area which shows that price is moving at a faster rate with respect to its earning.
Previous two times when Nifty crossed P/E of 22, the earnings growth was strong, following the trend of P/E.
However, the scenario is not the same this time since earning is coming down while P/E is still heading up i.e contradictory.
This shows market has moved up just on the hope of optimism, but reality is completely different.
History says that whenever Nifty goes above 22 P/E, the market sees a correction. It would be important to see what happens this time?
It is usually seen that most of the money comes into mutual funds when Nifty is in overbought zone and very few people invest in the oversold region.
Though in reality, it should be opposite, thus reflecting the psychology of herding mentality.
To know more about Fundamental analysis you can enroll in NSE Academy Certified Equity Research Analysis course on Elearnmarkets.com.
However, with the huge optimism build on Modi government, the market has already rallied much. Let’s see, whether the government will be able to deliver the result and if so, then market may continue to rally further.
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Want to know more about Nifty P/E Ratio? Enroll for NSE Academy Certified Equity Valuation & Financial Modeling course that provides practical exposure to people who believe in the concept of long term investment and value creation..