‘Is it a good time to invest in the stock market?’ If you are an investor in the Indian equity market and either put money directly into equities or through a mutual fund, you’ll have to answer this question often for yourself of for your friends and relatives. Is there any single piece of statistics that can tell you how expensive or cheap the market is at any specific point in time?
For Indian investors, the easiest way to find out if it is a good time to invest is to compare the index level of either the Sensex or the Nifty to the earnings of all the index companies. This shows an investor how much he is paying for every rupee of earnings. This valuation metric is captured by the stock market Price to Earnings Ratio or PE and serves as an objective measure of how expensive or cheap the market is at any given point of time.
Morningstar’s Guide to Winning in the Market
In the context of the Indian equity market, it has been observed historically that investments made when the Sensex PE is relatively low earned better returns while those made when the market valuation is high either earned meagre returns or ran into losses. By simply buying more of an index fund or a diversified equity mutual fund when the market valuation is low will thus help any layman investor to do well in the equity market. If there is a need to invest a certain amount of money at regular intervals, it is better to invest more in equities when the PE is low and more in debt when the PE is high. This is a far better strategy of investing in the equity markets than mechanically select a Systematic Investment Plan (SIP).
It is the dream of every investor in the stock market to buy low and sell high. One of the ways of doing that is to time your entry and exit based on the market valuation. The chart below would give you an idea of how the Sensex PE determined the returns investors received in the last 20 years.
Source: The Economic Times
It is evident from the chart that your chances of earning a positive return from the equity market are much higher if you invest when the PE ratio is 18 or below. At the same time your chances of making losses as compared to other more secure investments like debt mutual funds or bank fixed deposits go up if you invest when the market PE ratio is 20 or more. It is not a very difficult task for an ordinary investor to keep track of the Sensex PE and invest accordingly either in equities or debt and perhaps to rebalance when the market goes way up or down.
Don’t know where to find the Price to Earnings (PE) ratio of the Sensex or the Nifty? These can easily be tracked on the websites of the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE). Or else please follow the links below:
Nifty 50 as on date
Sensex as on date
You can also use IDFC Mutual Fund’s PE Ratio Scale to have an idea as to whether the Indian equity market is cheaply or expensively-priced and decide on whether you should put more money into equities at any given point of time.
In today’s post Value Research’s Dhirendra Kumar has written on the misconception that mutual fund investors have about dividends. But most investors are aware that there is a difference between dividends from stocks and those from the mutual funds. Whereas in stocks, dividend means an additional income, in mutual funds the investor is withdrawing a portion of his own money. If I am paid Rs. 2000 from my mutual fund investment as dividend, the value of my investment will decrease on the date it is paid exactly by the same amount. So, Mr Kumar suggests that even if an investor needs regular income, it is better to keep his investments in the Growth Option of the fund and withdraw the amount he needs or to execute a Systematic Withdrawal Plan (SWP) to meet his monthly needs.
While admitting that it is wrong to think of mutual fund dividends as an additional income, an astute equity fund investor may not buy this argument. We must remember that dividends from equity funds are not taxed in India on the date of this post. The fund house does not pay Dividend Distribution Tax (DDT) while paying the dividend and the dividend is also tax-free at the hand of the investor. So, if an investor gets a dividend, he is earning tax-free income from day one. If he invests in the Growth Option of the fund, he will have to wait for one full year before any gains he made would be free from Long Term Capital Gains tax. Moreover, for the dividend payment no repeated action is required from the investor other than initially opting for the dividend option.
Secondly, if we want some sort of an income from our equity investments and want to withdraw some money, the fund manager may be in a much better position to judge when to take it out considering the market conditions, immediate prospect of earnings and valuations. So, one may ask that if the investor expects some income from his equity funds, isn’t the fund manager in a better place to decide when to pay dividends rather than the investor himself withdrawing some portion of his investment? If the fund manager is an expert on when, where and how much to invest, isn’t he also a better judge of when to take some money off the table and hopefully put it in the investor’s pocket?
The only drawback of the Dividend Option is that there is no certainty that dividends will be paid, nor is there any guarantee of the frequency and amount of that payment. But if an investor can take such uncertainties in his stride, it is much better for him to opt for the Dividend Option of an equity mutual fund rather than the Growth Option. There are funds like BNP Paribas Dividend Yield Fund that has been paying monthly dividends without fail for many years now. Some other funds, like Tata Equity PE Fund, have trigger options and declare dividends when the NAV increases by a certain percentage or the fund value crosses a certain threshold.
However, if you are an investor in non-equity debt or liquid funds which attract a DDT of more than 28%, unless you fall in the highest 30% tax bracket, it is better to opt for the Growth Option and start an SWP, preferably after three years, if you need a regular withdrawal.