Is the Indian stock market now cheap?

Has the Indian stock market become cheap after the fall this year?

But first, as I have said in the past, the concept of cheap or expensive depends upon the investor's time horizon and his/her return requirement. What is expensive for one investor can be cheap for another.

Having said that, sometimes we agree to some ballpark measure of cheap and expensive. So is the Indian stock market cheap now as many 'experts' and fund managers opine?

Here are some facts for you to decide yourself:
-As on 20 August 2008 closing, the BSE Sensex level was 14678 with a PE ratio of 18.22, Price:Book Value (PBV) at 3.80 and a dividend yield of 1.26%. All other things being equal, the lower the PE and PBV, the cheaper are stocks. The higher the dividend yield, again the cheaper are stocks.
-The corresponding figures for the Nifty 50 are 18.43, 4.02 and 1.27% respectively.
-The BSE 200 index comprising 200 stocks, had a PE of 18.52, PBV of 3.53 and Dividend Yield of 1.15%.
-Let us look at history to get an idea about this. Here is the data for the same during past lows:

Index: BSE 200
Date------------PE------PBV----Dividend Yield(%)
23 Oct 1998----10.74----1.2------2.68
24 Apr 2003----9.86----1.42-----3.42
17 May 2004---12.17----2.14-----2.6
11 Jun 2006----14.80---3.21-----1.75
20 Aug 2008---18.52---3.53-----1.15 (Current)

Compare this with the current valuations mentioned above.

Valuations seem twice as expensive as they were in April 2003. Ok, you might say that the frontline stocks are not cheap. How about the midcaps and small caps?
The NSE Midcap index quotes at a PE of 13.09. The PBV is 2.32 and a dividend yield at 1.64%. A PE of 13.09 does not seem expensive...looks cheap in fact!
Except that midcap companies are exactly that. They do better than large caps in good times and poorer during bad times.
To know what cheap really means, have a look at the same values for the same index in April 2003: PE = 6.28, PBV = 0.93, Dividend Yield = 4.67%!

So while the midcaps might have been very cheap in 2003, current valuations, though not expensive, are not as cheap and can get cheaper. Again, today midcaps are twice as expensive as they were in Apr 2003!

-The market capitalization (value of all stocks traded) of Indian stocks to GDP ratio (Market Cap:GDP ratio) currently stands at close to 1.1
-Market Cap:GDP ratio stood at 0.25 in April 2003, at 0.42 in May 2004, at 0.32 in March 1979
-The higher this ratio, the more richly stocks are valued.

Mutual fund managers and experts will have us believe anything. They give an example showing how the BSE sensex went up 18% compounded since 1979. So they advise people to buy stocks and mutual funds (so that they can get their Rs. 1 crore bonuses). They however forget that the starting point in 1979 was low (market cap:GDP = 0.32).
Had the market cap to GDP been 1.1 (current levels), Sensex in 1979 would have been at 340 and the compounded returns till date would have been 14% and not 18%! Still good, but much lesser than 18%.


Consider a few more facts:
-The period from 2003 onwards was characterised by low inflation and low interest rates. Inflation now is above 12%. High inflation is not good for stocks.
-The yield on a 10 Year Government of India security ranged between 5.8% to 7%. Currently it is close to 9.5%. Generally, PE values and interest rates are inversely related.
-High interest rates are not good for stocks. High interest rates reduce corporate earnings, slow down growth, make fixed income securities more attractive and hence reduce the attractiveness of stocks.
-The world is slowing down and so is the Indian economy
-Foreign money is the primary driver of Indian stock markets. From 2003 to 2007, the rupee appreciated from R.48/USD to Rs.39/USD, an appreciation of 23%. This added to the gains of foreign investors. This year alone, the rupee has depreciated more than 10%, adding to losses of foreign investors.
-India has a large trade deficit. With high oil prices, the deficit has widened and is unlikely to be filled up by a net capital inflows. A net negative balance puts downward pressure on our currency, making it depreciate and hence a poor choice for foreign investors. Also, unlike China, a large chunk of our foreign reserves are not owned by us but is kept on behalf of foreigners.
-India has a large fiscal deficit (including the off balance sheet items like oil bonds). A high fiscal deficit tends to push up government borrowing and hence push up interest rates, not good for companies and stocks. With a world credit crisis and foreign money unlikely to be available as easily as earlier, it could well 'crowd out' some private investment and cause further slowing down in the economy.
-With the bursting of a long 25 year credit bubble in the developed world, things for the investing arena have changed. Credit is unlikely to be anywhere as free or cheap in the coming years. Tremendous changes are occuring in the developed countries, particularly USA, which is altering the investing landscape. It is not wise to extrapolate past trends blindly into the future.
-Stocks had a wonderful environment to perform over the last few years. High growth, low interest rates, low inflation, cheap credit, excess capacities, all contributed to a the superior performance of stocks. Good times do not last forever (neither do bad times) and conditions now are the reverse of earlier ones.


There is a Chinese saying that goes something like this: "There is a time to cast your net and there is a time to dry your net."

The time for fishing got over when storms appreared earlier this year. The time to go fishing again has, in my opinion, not yet arrived. It is time to dry you nets, wait for the storm to blow over and for the fish to come back closer to your shores.