What Is the Nifty PE Ratio, and Should You Care?

PE stands for price to earnings. For a single company, it is the share price divided by the profit per share. If a company earns Rs 10 per share in a year and its share trades at Rs 200, its PE is 20. Investors are paying twenty rupees for every rupee of yearly profit.

A high PE can mean investors expect strong growth in future, or that the share is simply priced high. A low PE can mean the company is out of favour, or that profits are expected to fall. These figures are only an illustration of the calculation.

The Nifty PE does the same calculation for the whole Nifty 50 index. It compares the combined market value of the fifty companies with their combined earnings. The index provider publishes it every trading day.

Our page on Nifty and Sensex explains how the index itself is built.

The idea is that if the market PE is much higher than its long-term average, shares may be expensive, and future returns from that point could be weaker. If it is much lower, shares may be cheap.

There is some truth in this over long periods. Buying when everything is priced very high has often led to slower growth afterwards. But "often" is not "always", and the timing is very hard to predict.

A market can stay at a high PE for years while earnings catch up. People who sold because the PE looked high have sometimes missed long rallies. Equally, a low PE can get lower in a crisis before things improve.

No single number tells you when to buy or sell. Our page on the best time to start a SIP explains why trying to time the market usually hurts more than it helps.

The PE moves when either prices or earnings change. If prices rise faster than profits, the PE goes up. If profits grow strongly while prices stay flat, the PE comes down even though nothing fell.

Earnings can also be unusual in some years, for example in a slowdown when profits dip temporarily. Then the PE can look high simply because the earnings figure is low for a while.

The way the Nifty PE is calculated has changed over the years, for example moving from standalone to consolidated earnings of companies. The companies in the index also change over time, and different sectors normally trade at different PEs.

So comparing today number with a number from many years ago is not a perfect like-for-like comparison. Treat long-term averages as a rough guide only.

Some investors also look at the price to book ratio, the dividend yield, or the total market value compared with the size of the economy. Each has its own limits.

Looking at several together gives a broader picture than any one alone, but none of them is a reliable buy or sell signal on its own.

A SIP buys every month, whatever the PE. When the market is expensive, your SIP buys fewer units. When it is cheap, it buys more. Over many years, this averages out the price you pay.

That is why most SIP investors do not need to watch the PE at all. Our page on rupee cost averaging explains how this works.

PE can help set expectations. When valuations are very high, it is sensible not to expect the next few years to look like the last few. It can also remind you to check whether your equity share has grown too large and needs rebalancing.

Some balanced advantage funds use valuation measures like PE to decide how much equity to hold. Our page on balanced advantage funds explains how.

• Stopping your SIP because the market "looks expensive".
• Moving all your money out of equity in one go.
• Putting a large lump sum in because the PE dropped a little.
• Comparing PEs across very different sectors or countries without context.

Valuation worries matter more for a large one-time amount than for a SIP. If markets look expensive and you are nervous, you can spread the lump sum over several months through an STP, rather than trying to guess the right day.

Our pages on STP and investing when the market is at a high explain this approach.

The index provider publishes daily PE, price to book and dividend yield figures for the Nifty indices on its website. Many financial websites also show them.

Be careful with social media charts claiming the market "must" fall or rise because of the PE. Those claims are guesses, not facts.

Mid cap and small cap indices also have PE ratios, and they often move more sharply than the Nifty 50. Smaller companies can see profits change quickly, so their PE can jump or drop a lot in a short time.

The same caution applies: use it to set expectations, not to time entries and exits. Our page on large, mid and small cap funds explains how these segments differ.

• PE compares price with earnings.
• A high Nifty PE means shares are priced high compared with profits.
• It is not a timing signal. Markets can stay expensive or cheap for long.
• SIP investors should keep investing regularly.

We are distributors rather than investment advisers and we recommend no schemes. If market valuations are making you nervous about your plan, get in touch.