Market Multiple Thesis
The other day I was reading an article when I came across something called market multiple (market P/E, market P/B and market div yields).
The thesis of the author was that with respect to CNX NIFTY (NSE), one could make very profitable investments in Equity, if one bought his/her stocks when markets were at a low market multiple (P/E of 11x) and exited once the markets reached a high market multiple (P/E 24x). Similarly also, when market book multiples are low, the potential for earning higher returns are more. In the same way, when market dividend yields are high, returns potential are high.
Study on Market Multiples
This got me thinking and I decided to test out these three hypothesis; I downloaded NIFTY data from NSE website starting from 1999 onwards till 2013 – index values, market P/E, market P/B and market dividend yields and performed simple correlation study between these variables:
- Market Multiple P/E vs 5 Year returns.
- Market Multiple P/B vs 5 Year returns.
- Market Dividend Yield vs 5 Year returns.
- Market Multiple P/E vs 10 Year returns.
- Market Multiple P/B vs 10 Year returns.
- Market Dividend Yield vs 10 Year returns.
The results are given below:
Conclusions of the study on market multiples and equity returns:
a. Definite conclusions from the study are:
– negative correlation between market P/E and long term returns (5 to 10 years) [i.e. the lower the market P/E, higher the returns and vice versa]
– negative correlation between market P/B and long term returns (5 to 10 years) [i.e. the lower market P/B, higher the returns and vice versa]
– positive correlation between market Dividend Yield and long term returns (5 to 10 years) [i.e. the higher the market Dividend Yield, higher the returns and vice versa]
b. But as to the strength of the association, I would say that none are very strong (maximum being 55%)
c. Degree of correlation is more for 10 year returns than 5 year returns
d. P/B is a better indicator than P/E or Div Yield
e. Dividend yield is a better indicator over the long term (10 years) as compared to medium term (5 years)
I hope you enjoyed this post on market multiples and equity returns. Please feel free to share and leave your comments.
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