Using Earnings Yield (E/P) to time your investments – a guest post

In last Thursday’s post, I had taken a look at the historical P/E ratios of the Nifty 50 index and suggested an investment strategy. In this month’s guest post, Nishit takes a slightly different view. He compares Nifty’s earnings yield with the 10 years G-Sec yield to time stock market investments.

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

Subhankar had written about Nifty’s P/E multiple or Price to Earnings Multiple last week. Let us delve deeper into it. He had written “Nifty’s P/E ratio has varied between 11 and 27 during the past 12 years - with peaks of 27.35 on Mar 1, 2000 and 27.64 on Jan 1 2008, and troughs of 11.62 on Jan 1, 1999; 10.86 on May 2, 2003 and 11.76 on Dec 1, 2008. The average P/E ratio over the past 12 years is 18.24.”

Price/Earnings ratio is nothing but the Market Price divided by the Profits per share of a company in rupee terms. Assume the share price of a company is Rs 100 and it makes a profit of Rs 10. So its P/E ratio is 100/10 = 10. It is a very fundamental ratio of finding out the valuation of a stock (or index). Now, P/E by itself has no significance. How do we know if P/E of 10 is stretched or P/E of 50 is stretched?

We look at the growth prospects of a company and sector. The derived ratio is PEG Ratio (Price to Earnings Growth ratio). Now if the company is going to grow at an annualized growth rate of 100% for the next 3 years, a P/E of 100 may be acceptable. This is especially true of the IT companies in the glory days of 1998-2001 when Infosys used to come out with 100% growth figures every quarter.

The inverse of P/E (i.e. E/P) is the earnings yield. It is the amount per annum you are going to earn by investing in a company. This ratio is very important in the sense that you can use it to find if a stock (or the Nifty) is over-valued or not. What will we compare against? Let us take the 10 years Government Treasury Bill return. This is the safest investment in the country. Whenever 10 years G-Sec yield is more than equity earnings yield that is the time to go long big time.

Let us take an example. During Oct ’08 – Mar ’09, the Nifty P/E ratio dropped below 15; the earnings yield was 6.66% and below. The G-Sec Yield was 7.83% in Nov ’08.That was the time when the long term portfolio of stocks should have been built up.

For the past 1 year, the Earnings Yield of the Nifty has been around 5%. The G-Sec yield is around 8%. At such times, exposure to equity has to be limited. That is, keep trailing stop losses and don’t add fresh equities.

The Earnings Yield is a simple extension of the P/E concept and comparing it to the Bond Yield gives us a perspective on finding whether the equity markets are overvalued as compared to the Bonds Market or not.

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

(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Planning for a hassle-free Retirement (a guest post)

Do you remember what you did with your first pay/payment cheque? (Haven’t received your first cheque yet? What are you doing on this page!) Did you blow it up having a good time with friends and family? Why not? You don’t remain young forever. There is a long and bright future ahead of you – and plenty of time to save and invest. Right?

Nishit doesn’t think so. He started planning for his retirement as soon as he received his first pay cheque. He wanted to use the leverage of compounding over his entire working life. In this month’s guest post, he explains why.

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

Everyone invests money with the aim of having a comfortable nest egg at retirement. Most of us have not worked out how much money we need at retirement, and at what rate of return we will be comfortable. Most of us chase multibagger returns in the equity markets, burning our fingers in the process.

The magic of compounding is such that 1 lakh invested in the markets today turns into 19 lakhs after 20 years at a rate of 16% return every year. To make 16% every year your asset portfolio need not take undue risks. A Government securities fund over the past 10 years has given a compounded return of 9% on an annualized basis, and a good mutual fund like the HDFC Top 200 has given annualized return of 34% over the past 10 years.

Inflation is a monster which is like a silent killer. Now assuming an inflation rate of 8%, after 20 years, expenses of 1 lakh become 4.66 lakhs. Your assets of 1 lakh have transformed into 19 lakhs whereas the expenses have just gone up to 4.66 lakhs. You have a nice cushion of 14 lakhs.

Gold as an asset class has also yielded an annualized compounded return of 17% over the past 10 years. The trio of equity, gilt funds and gold should form the cornerstone of any investment portfolio. What I am trying to point out here is that investments need not be complex; any common person can invest making use of investment vehicles like Mutual Funds.

The above returns are through investments using the SIP (Systematic Investment Plan) method. One can invest a fixed amount every month, say Rs 5000 each, in a gold ETF, equity fund and a Debt fund. The idea of doing this is that you do not try and catch the bottom or top of any market. One need not invest in too many funds at one go.

India’s economy is growing and will continue to do so for the next 10 years at least. Anyone who is planning to retire with a comfortable income must start doing a SIP at the earliest. By doing this, one can ensure that one is financially independent after retirement. Add to this a Medical Insurance policy that will cover major health care expenses post retirement. The earlier one buys a Medical Insurance policy the fewer are the tests one has to undergo and easier it is to get one. Everyone should have a personal medical health insurance policy, as company policies expire when one leaves the company.

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

(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)