THE STANDARD RULE for any investor buying equities is buy low, sell high. Which is why experts advise buying when there’s a crash in stock prices, assuming that the fall is driven by investor sentiment. By that logic, this would be the perfect time to buy: the 30-stock BSE Sensex is down over 15% from the all-time intra-day high of 21108 it touched on the day after Diwali last year. Many individual stocks in sectors such as banking, infrastructure, capital goods and realty are down 30% to 40% from their recent highs.

The market appears fairly valued, but this is not the best time to go shopping for stocks. Sensex valuation ratios are still not compelling; as the first chart on the right shows, the market has been much cheaper in previous bear runs.

The Sensex was valued at nearly 20 times the weighted average earnings of its 30 constituent stocks in the last four quarters (as on Feb. 18). This is hardly compelling, seen in light of the fact that its 10-year median price-earnings ratio (P/E) is around 18. During the market meltdown of 2008 and early 2009, the P/E had fallen to a low of 10.4. While 2008 could well be an aberration, all other major corrections, in May 2004 and May-June 2006, for instance, rebounded when the valuation fell to around 15.

The second chart illustrates another way to map market valuation: to compare the relative movement in the Sensex with the underlying growth in earnings, book value (or net worth) and dividend.

At the current level, the recent correction has brought the Sensex in line with the underlying trend in earnings growth. At the same time, the index is ahead of the other two valuation ratios, meaning that there’s still scope for it to come down. Once that happens, valuations will be low enough for investors to go cherry picking.

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