What do the Buffett indicator and PE ratio conclude about the Indian market?

According to these indicators, the Indian equity market is expensive!

Indian equity bellwether index, NIFTY50 has fallen more than 15 per cent in the last 8 months. In the same period, the S&P 500 is down 13 per cent. Many of the stocks are down by more than 20 per cent and are into a technical bear market. Many investors who had missed the bus earlier may look at this as a buying opportunity, following the famous 'buy on dip' strategy.  

However, investors should not look at the Indian Equity market on an isolated basis. Investors should also consider the relative valuations of Indian equities relative to the other major equity markets and especially emerging markets. This fall has made valuation ratios of the equity market near their fair value.

When we talk about valuation, one of the most important ratios to consider is the PE ratio. The PE ratio of an equity index of a country would tell us about the equity market valuation of a country relative to the earnings capacity of its publicly traded companies. 

Following is the comparison of the PE ratio of major economies. 

The higher the PE ratio, the more expensive the market. 

According to the PE ratio, currently, the US, Japan, China, Brazil, Germany, and Russia are trading at an attractive valuation relative to Indian equity markets. 

The other most famous valuation metric to use for determining the equity market expensiveness/attractiveness of any country is the Buffett Indicator (Market capitalization/GDP). Everyone knows about the most famous investor of all time, Warren Buffett. However, only a few investors actually understand and follow his investing principles in order to make money in the market. 

The buffett always looked at market capitalization to the GDP ratio of a country to decide the expensiveness/attractiveness of the country’s equity market for long-term investing.  The buffett indicator is a measure of the total value of all the publicly traded companies relative to the Gross Domestic Product (GDP) of the country.  

Following is the Buffett indicator of the major equity markets 

The higher the Buffet Indicator, the more expensive the market. A buffet indicator of more than 100% indicates that the total equity market value of a country is larger than its GDP. According to Buffet Indicator, UK, Brazil, Germany, and Russia are currently less expensive than the Indian equity market. 

Hence, one can conclude that the Indian equity market is relatively more expensive than other major equity markets in the world. 

Therefore, investors should not just look at the price discount that the NIFTY50 is currently offering, compared to its October 2021 high; and avoid making short-term bets, wishing for a reversal solely based on the NIFTY or Sensex price action.