On 14 Oct 08, the Sensex is below 10,000 (at 9,975) and all the folks who entered the market after July 2006 (seems a long way back no?) are wondering if this madness is ever going to stop! Certainly, it will stop but the more important question is what you and I are going to do when the fall stops? Are we going to buy or sell?

There are some significant opportunities that the Market has thrown up for the Investor and those who believe in the growth of India. But to understand that, we need to look at something very different from where the Market’s attention is right now.

Most people look at Price and decide to buy (or sell) something. However, history has consistently shown that far more important that Price is Value! The more important issue being, is there Value in the Price that I buy something at.

To understand Value vs Price, let’s understand a concept that is known but certainly not widely followed, especially by Retail investors, the Price Earning Ratio or PE Ratio.

PE Ratio is:                                           Price of the stock

                              --------------------------------------------------------------------

                               Earnings (Profits) that the company has made per share

What the PE Ratio does is that it gives us an idea of how Expensive or Cheap a stock is priced. To illustrate:

 

Company	Price of the share	Earnings per share	PE Ratio
A	1,000	100	10
B	100	5	20

As you can see from the table above, even though Co A is more expensive at Rs. 1,000 it is actually cheaper in terms of value than Co B. Conversely, while most people would buy Co B as it looks cheap at Rs. 100, it is actually double at expensive at Co A.

Just as one can look at Value of individual shares, one can look at the Value of an Index, the Nifty or the Sensex. Basically, it the Price of the Index divided by the profits per share of the individual companies in the proportion that they compose the index. Hence you get the PE of the Index.

The Nifty PE Chart tells us over a 10 year period how the Market has Valued itself over various important events.

Chart Lesson 1: The Market PE peak is around 28

During the Internet bubble of 1999-2000, the PE peaked at 28 and then reacted sharply down from there. Again in the Speculative bubble of late 2007 to Jan 2008, the PE peaked at 28 and yet again dropped off sharply from there.

Chart Lesson 2: The Market PE has a base of around 12

Start of 1999, in 2001 and 2004, the Market went to a PE of around 12 and notice again that it bounced from there.

Chart Lesson 3: Crises of Confidence PE at around 11

In 2003, the unthinkable happened, a coalition government of the Congress and Left parties came to power. In the “Crises of Confidence” and despair that followed, the Market’s PE fell to a low of 10.8 and bounced sharply from there.

Of course, it doesn’t mean that the Market PE can’t fall lower but it will need a bigger Crises of Confidence for this to happen. Is that the current situation, I think not!

Where are we now and where could be we go?

Sensex: 9,975

Nifty: 3,074

PE: 13.15

as on 17 Oct 08

This means we are 1 point above the base of 12 PE and 2 points above a Crises of Confidence PE. That 1 and 2 points on the PE translate to a 7.5% and 15% fall from the current levels.

IF the Markets do fall further, then we are looking at these potential 7.5 to 15% falls which translate to 9,226 and 8,478 on the Sensex and 2,843 and 2,614 on the Nifty.

A Very Happy Diwali!

Yes, I know that these projections look quite dire and some of us might have started sweating; BUT REMEMBER that the Market handsomely bounced (for at least 6 months in 2001 and for 3 years after 2004) from these PE levels consistently in the past and are very likely to do so once again!

These are levels we have seen once in 3 years and crises like the once we are going through will pass and the Market has presented us great buying opportunities.

If we do reach the Sensex and Nifty levels mentioned above, they will very likely happen around Diwali. In my view, the 2008 Diwali is when the Market is giving us real Bargains. Now whether you and I buy at these levels or we are overcome by fear and say no to the markets is entire up to us.

Don’t miss this Diwali, buy now and don’t open this Diwali gift for many months and years! A very Happy Diwali to ALL of US.