Is the Sensex Undervalued?
Looking at annual returns, 2015 and 2016 were rather forgetful years for the BSE Sensex Index.
At current levels, the index is still down around 10% from its all-time highs. It has been a testing time for those who've stayed put in equities.
How do the prospective returns look for the index? Can we expect attractive returns from the current levels in a decade's time?
Let's see what insights we can glean by tracing the index's historical returns using one crucial valuation metric - price-to-book value (PBV).
- It seems logical that before even thinking of buying any common stock, the first step is to see how money has been most successfully made in the past. - Phil Fisher
Please note this is not an attempt to forecast index levels. This is only an attempt to study the history of markets to gain some insights.
Now, using twenty years of BSE Sensex PBV data, we calculated ten-year CAGR rolling returns while noting the historic PBV.
For example, 30 March 2007 has a 10-year CAGR return of 13.5%, and the PBV on 31 March 1997 was 2.5.
The results are tabulated in the table below. A PBV of five and above indicates market levels are expensive. A PBV of three to five means the markets are fairly valued. A PBV of less than three indicates undervaluation.
| Price to Book - Valuation Band | 10 Year CAGR Returns (%) | Median Returns (%) |
|---|---|---|
| Greater than 5 | 6.5% - 12.4% | 7.7% |
| Greater than 3 and less than 5 | 7.0% - 18.1% | 13.4% |
| Less than 3 | 8.0% - 21.1% | 16.9% |
You see, in the past, if you bought the index when its PBV was three or lower, you would have earned ten-year CAGR returns of 8-21.1% and an impressive median return of 16.9%.
Meaning you would have multiplied your money 4.8 times.
This simple test can give a crucial insight on the valuations of broader markets to help make an informed decision.
As on 30 December 2016, the BSE Sensex traded at a PBV of 2.7 times, firmly in the undervalued zone.
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