The BEER Ratio Explained: Your Ultimate Guide to Spotting Undervalued and Overvalued Markets!
Bond Equity Earnings Yield Ratio consists of taking a benchmark for bond yields (like the 10-year Indian Bond) and dividing it by a benchmark for stocks (like the Nifty 500).
Today, we are talking about BEER—no, not the frothy, chilled kind you grab after a long day, but the Bond Equity Earnings Yield Ratio. Now, before you try pouring this BEER into a glass, let me warn you: it won’t quench your thirst, but it might give you some insight into whether the stock market is feeling tipsy or sober. Let’s dive into the most financially intoxicating topic you will read all day!
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The Bond Equity Earnings Yield Ratio complements Benjamin Graham's price-to-earnings ratio and the relationship between bond yields and P/E ratios.
What is the BEER?
The Bond Equity Earnings Yield Ratio, in theory, is supposed to signal the direction in which the stock market is going and whether the stock market is undervalued or overvalued. The ratio consists of dividing the benchmark yields of bonds and stocks.
In the case of the Indian market, you would take the 10-year India bond yield and divide it by the Nifty 500 yield. This also works for any other country or market as long as you put in the numerator the government bond yield for the particular country or market you’re analysing and divide that by the yield for an index capturing the broad stock market for that region.
To compute the Bond Equity Earnings Yield Ratio for the Indian market, we first need to figure out the 10-year India Bond yield, which is about 6.77 at the time of writing this article. Then, we calculate the earnings yield of the Nifty 500 by taking the inverse of the P/E ratio. In this case, the P/E ratio is about 24.9 for the Nifty 500. Dividing bond yields by the inverse of the P/E ratio gives us a ratio of 1.68.
1. Earnings Yield Calculation
Earnings Yield is the inverse of the Price-to-Earnings (P/E) ratio.
Earnings Yield=1/ (P/E)×100
Given P/E = 24.9:
Earnings Yield = (1/24.9) × 100 = 4.02 per cent
2. Bond Equity Earnings Yield Ratio (BEER) Calculation
The BEER ratio compares the earnings yield of the equity market with the 10-year bond yield.
BEER=Bond Yield/Earnings Yield
Given:
- Bond Yield = 6.77 per cent
- Earnings Yield = 4.02 per cent
BEER = 6.77/4.02 = 1.68
BEER < 1 --- Overvalued
BEER > 1 --- Undervalued
What does this mean?
It seems that the market is undervalued, given that the ratio is above one. But what does this exactly mean? According to proponents of this theory, if the stock market is undervalued, the assumption is that the market is bearish, and stock prices are expected to drop with a trigger of a negative situation. This indicates a good time to invest in bonds. On the other hand, if the stock market is overvalued, the assumption is bullish—stock prices will continue to increase, making it a more favourable time to invest in stocks.
Historical data
The problem is that the market will be bullish or bearish until it isn’t anymore, and predicting the moment of change is very hard. Looking at historical data from macrotrends.net, here we summarised this in a table.
|
Year
|
Historical P/E Nifty 500
|
Earnings Yield (in Per cent)
|
10-Year Indian Bond Yield (in Per cent)
|
BEER
|
Nifty 500 Index
|
|
1998
|
12.04
|
8.31
|
12.21
|
1.47
|
609.06
|
|
1999
|
25.68
|
3.89
|
11.20
|
2.88
|
1205.01
|
|
2000
|
19.43
|
5.15
|
10.88
|
2.11
|
912.85
|
|
2001
|
14.82
|
6.75
|
7.94
|
1.18
|
700.6
|
|
2002
|
14.02
|
7.13
|
6.08
|
0.85
|
772.85
|
|
2003
|
17.78
|
5.62
|
5.12
|
0.91
|
1531.35
|
|
2004
|
17.17
|
5.82
|
6.71
|
1.15
|
1804.9
|
|
2005
|
18.58
|
5.38
|
7.11
|
1.32
|
2459.2
|
|
2006
|
19.84
|
5.04
|
7.62
|
1.51
|
3295.05
|
|
2007
|
26.4
|
3.79
|
7.79
|
2.06
|
5354.7
|
|
2008
|
11.8
|
8.47
|
5.26
|
0.62
|
2295.75
|
|
2009
|
20.78
|
4.81
|
7.68
|
1.60
|
4329.1
|
|
2010
|
22.24
|
4.50
|
7.91
|
1.76
|
4940.95
|
|
2011
|
15.87
|
6.30
|
8.56
|
1.36
|
3597.75
|
|
2012
|
18.43
|
5.43
|
8.05
|
1.48
|
4743.45
|
|
2013
|
18.99
|
5.27
|
8.82
|
1.67
|
4914.85
|
|
2014
|
21.96
|
4.55
|
7.86
|
1.72
|
6773.65
|
|
2015
|
23.6
|
4.24
|
7.76
|
1.83
|
6724.75
|
|
2016
|
25.25
|
3.96
|
6.51
|
1.64
|
6982.8
|
|
2017
|
32.55
|
3.07
|
7.33
|
2.38
|
9490.65
|
|
2018
|
29.61
|
3.38
|
7.37
|
2.18
|
9170
|
|
2019
|
30.84
|
3.24
|
6.55
|
2.02
|
9872.55
|
|
2020
|
43.39
|
2.30
|
5.89
|
2.56
|
11518.3
|
|
2021
|
25.44
|
3.93
|
6.45
|
1.64
|
14996.2
|
|
2022
|
22.85
|
4.38
|
7.33
|
1.67
|
15448.85
|
|
2023
|
24.48
|
4.08
|
7.18
|
1.76
|
19429.15
|
|
2024
|
25.56
|
3.91
|
6.76
|
1.73
|
22375.4
|
Over the last 25 years, the Bond Equity Earnings Yield Ratio and Nifty 500 index reveal that in the years leading up to the 2008 crisis, the ratio was below 1, indicating an overvalued market. In 2009, the market was undervalued when the earnings yield for stocks was 8.47 per cent while the bond yield was 5.26. Since then, earnings yield has increased, bond yield has decreased, and the ratio has remained below 1, while the Nifty 500 index continues to rise on average.
What stood out in the last 20 years is that every time the ratio crosses one, there seems to be a change in the direction of the Nifty 500 index. This could indicate potential buying or selling signals. However, the market can continue to climb or drop for many months or years before a bull or bear trend becomes clear.
Conclusion
Most investors fail at timing the market. Historical data trends and patterns can offer insights, but predicting new market conditions and their direction remains difficult. A safer strategy is to keep a significant portion of your portfolio in an index fund that tracks the Nifty 500 or the total market index. Frequent contributions through dollar-cost averaging help mitigate market valuation concerns. Over time, the market smooths out losses, yielding average annual returns of 8-9 per cent.
Disclaimer: The article is for informational purposes only and not investment advice.