what moves market

Nifty closed at 5,787.60 yesterday. Some rally was seen in the past few days due to positive news regarding the reforms by the government.

Historical values for nifty are shown below:

 

The nifty

What do you make of these? Nifty has had a steady rise since 1994; peaked at 6274 in January 2008; bottomed out at 2553 in November 2008; and peaked again at 6312 in November 2010.

 

In the interim many things happened - good news, bad news, good results, bad results - however, the march was on as we can see.

 

The biggest fall came in 2008 from the January peak to the October low (a fall of more than 3500 points). Compare this to the fall after IT bubble in 2000 where nifty fell from the peak of 1756 (February 2000) to the low of 1045 (September 2001).

 

As we stand now, nifty is not very far from 6000 levels; whether it will breach that, time will tell. While it is inching higher, the key question is how high it is now. Is it expensive or is it cheap? We cannot tell this by just looking at the absolute nifty values. We will have to relate these values to some other values, more prominently earnings.

 

The earnings 

If increase in nifty values are generally in proportion to that of the total earnings of the index companies, it should be fine. After all, businesses are meant to grow. If not, it tells you that there is a gap between the price and value. It could either be a buyer's market or a seller's market depending on the type of the anomaly.

 

The high points of price-to-earnings were at 28 in February 2000; at 22 in March 2004; back to about 28 in January 2008; and at 26 in October 2010. 

The low points were in May 2003 at about 11; in June 2004 at 11.62 and then again in October 2008 at 10.68.

This should remind us of the bubbles of 2000, global crisis of 2008 and the aftermath.
 

With the current multiple of 19, it is about 33% lower than its peak value. How cheap the value is depends on whether and how soon we will get to see the peak multiple again.

 

The dividends

Dividends after all are paid out of earnings. It is logical to relate dividends to earnings and hence, dividends to market values.

 

Dividend yields from nifty have never been great. In May 2003 a high dividend yield of about 3% was recorded; since that time it reached to about 2.6% in 2004.

 

Lowest yield of about 0.6% was in May 2001 although p/e multiple was only at 15; this suggests that probably the companies backed out from paying dividends during the period. The low point of the yield at 0.8% in January 2008 corresponds to the high valuation.

 

The current yield of about 1.4% is not very attractive either. If you are looking for good dividend yields, better look for specific companies having more stable earnings.  

 

Price-to-dividend multiple is the reverse of the dividend yield. Accordingly, the graph should be the mirror image. Just like p/e multiple shows how high or low valuations are compared to earnings, p/d multiple shows in relation to dividends.

The book
Price-to-book multiple compares the market prices to the book values. A high multiple suggests high valuations and vice versa. The differences between the market and book values are due to goodwill component of the business itself. This is reflected by the earning power of the business. However, if earning power is lower compared to the price attached by the market, it reflects something else - both p/e and p/b can be outrageous!

This multiple only reconfirms our analysis drawn from the earnings and dividends. Usually you see high p/e, high p/d, low dividend yield and high p/b going together.
 

With the power of hindsight the best time to pick stock was in late 2008, second-half of 2001 and of course just before the beginning of the bull market in 2003. If only we had the foresight!

All we can say now is that the market does not look very expensive as per the past records; it is not very cheap either.

If earnings and cash flows are likely to grow, and inflation and interest rates can be contained, the current valuations look good; if not, you know what I mean.