One of the biggest concerns today among investors is whether stock markets are overvalued. With so much of doom and gloom about the economy, the rising stock market doesn’t make sense. So, for many, it all looks like another bubble waiting to pop.
As in life, history is our biggest teacher in stock markets too. Lessons from history helps us overcome our emotional biases and help us see beyond the illusions. This is what this graph attempts to do!
Price to Book Value (PB Ratio) is the most reliable ratio to gauge the overall health of stock markets. History tells us that if this ratio is too high, it is risky to invest. At very high PB ratios, investors are bound to make losses in the near to mid-term. The previous two bubbles got pricked at a high PB valuation of 4.95x (Dot Com in 2000), and 6.05x (2008 Subprime Crisis and Infra bubble). On the contrary, if the PB ratio of the broader market is low, investors will make high gains in the near to medium term.
The historical analysis shows that NIFTY 50 & Midcaps are fairly valued. Together, this is nearly 80% of the total market. Sentiments are too weak in AUTO, Energy, Metal, Media, PSU and Small Caps. That’s why they are available at very attractive valuations. The cycles will keep repeating. The losers of yesterday will become winners of tomorrow, and vice versa. That’s why we should fine-tune our portfolios regularly!