Thursday, October 05, 2006

Odds of Making Money in the Stock Market

I was surfing through some blogs and came across Value Investor India, a real gem of a blog that is not updated frequently but has some really good posts. It is based on value investing concepts and has some really good posts on arbitrage and industry overviews. Rohit, the author, has obviously gone deep into the internet to dig out some really good stuff, such as this arbitrage returns evaluator, which seems to be based on what I read in Buffetology (or maybe that's just how all arbitrage stock opportunities are evaluated).

Anyways, one post caught my attention, as it seems to be a pretty interesting way to look at timing the market. Basically, the concept is that you should take the current PE and be able to judge the odds of making money in the market based on how often the PE has been higher than this in the past. If today's PE is towards the higher end, then chances are you will lose money in the medium term.

The NSE, and perhaps even the BSE, site allows visitors to download historical index data (open, high, low, close, PE etc) into excel sheets. Now, once you have downloaded the data, it is fairly easy to count the number of times the PE has been higher than the current PE and divide by the total number of days in the historical period considered in order to get an idea of the probability of it being higher than today in future.

Example:
If today's PE is 18 and you see that over the past 1000 days the PE has been >18 50 times and <=18 950 times, then chances of you making money in the future are 5% and chances of losing money are 95%. So you might want to keep your money in the bank for now.

The obvious flaw in this approach is that as markets in India mature and growth slows down, future PEs might be generally lower than past PEs, thereby throwing your calculations out of the window. Further, since you are looking at an index PE, it would be wise to invest in an index fund on this basis. It might even be better than a passive SIP and yield better returns...

Why would this not work for individual stocks? Because individual stock PEs should not be anallyzed statistically as they are completely dependent on management and factors affecting the individual company. For a basket of stocks such as the index, the approach does provide a good rule of thumb.

If you have bought stock funds in a period when the odds were good of PEs rising in future, you'd probably have really done well, benefiting from the increased PE as well as rising earnings, a double benefit!

The example given in the post was that of the stock market crash during the UPA elections when apparently the odds were 10:1 of PEs rising afterwards - and of course the market soared over the next couple of years!

Anyone want to try this out and let us know today's odds?

8 comments:

sharetipsinfo said...

Hi,

Indian stock market is one of the most volatile market. Its two main stock exchanges are NSEand BSE. Both exchanges generally follow same trend.

NSE and BSE offers platform for investment in Indian stock market. In India there are many traders who prefer NSE over BSE as they consider BSE
as more volatile exchange but truth is that all exchanges be it NSE, BSE or LSE are volatile and should not be considered as a place for speculation.
One should strictly follow technical analyses if they want to earn regularly from any stock market.

Please remember analyses of stock market be it technical or fundamental do help!!

Regards
SHARETIPSINFO TEAM

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jane said...

I've stopped by here a couple times and it looks like your blog posts get more informative each time. Keep it up I enjoy reading them.

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sanjeev said...

Stock market India is volatile and all those who speculate in market are loosing everyday. Please remember stock market is not for speculation purpose. If one feel investing in stock market is gamble then its better to think again.
One should always note that if they want to invest money they should do proper research be it fundamental research or technical research. Just think how come you can invest
your money without any convincing reason for the same?
Indian stock market is one of the most happening and emerging market. Major Indian stock exchanges are BSE and NSE and both are of world class standards.
So grab good stocks and invest that’s the bottom line.
We hope to see you in major profits.

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