The Price You Pay Today Determines Your Returns Tomorrow

Every investor faces the same question: Is now a good time to invest? Analysis of Indian stock market data spanning nearly two decades reveals a clear answer – timing based on market valuations does matter, more than most investors realize.

Understanding CAPE: The Valuation Compass

CAPE (Cyclically Adjusted Price-to-Earnings ratio) is a measure that smooths out temporary earnings fluctuations by comparing current stock prices to the average inflation-adjusted earnings over the past decade, specifically using a 10-year (120-month) rolling average of inflation-adjusted earnings. Originally developed by Nobel laureate Robert Shiller, this metric helps identify whether markets are expensive or cheap relative to their historical earnings power.

Recent research by Joshy Jacob and Rajan Raju (July 2024) provides an in-depth analysis of CAPE’s predictive power in Indian markets from April 2006 to June 2024. Building on the CAPE series developed in their research, we conducted additional analysis by classifying market entry points into percentile buckets based on 3-year rolling windows of CAPE values and tracked subsequent 5-year returns to assess entry timing impact.

Our percentile analysis begins from May 31, 2009, when sufficient 3-year historical CAPE data became available. This approach provides a relative valuation framework rather than relying on absolute CAPE numbers alone - a 3-year percentile ranking shows where current valuations stand compared to recent history, making it more actionable for investors than static threshold levels.

What the Numbers Show

The findings are striking. Analyzing all possible 5-year investment periods from May 2009 to October 2025, when investors entered the market during periods of:

The overall average rolling 5-year return across all entry points during this period was 13.88%. However, the data shows that entry timing could have significantly improved or reduced this outcome. The difference between the best and worst entry timing amounts to a remarkable 4.5 percentage points annually.

The Valuation Advantage

The data reveals a clear pattern: entering at lower valuations provides a meaningful advantage. While the average rolling 5-year return of 13.88% represents solid wealth creation, investors who timed their entries when valuations were below the 30th percentile could achieve returns of 15.26% annually - 1.38 percentage points above average.

Conversely, those entering during the most expensive periods (above 90th percentile) saw returns drop to 10.75% – still positive, but 3.13 percentage points below the average.

Why This Happens

Think of the stock market like buying a house. If you pay a very high price relative to the rental income it generates, your future returns will be lower. Similarly, when stock prices are high relative to company earnings, future returns tend to disappoint.

Our analysis used a 3-year rolling window to classify CAPE percentiles, ensuring we captured meaningful valuation cycles rather than temporary fluctuations. This approach reveals that valuation-conscious investing isn’t about perfect timing but about recognizing when markets offer better or worse long-term value.

The Current Reality Check

As of October 2025, India’s CAPE ratio stands at 40.24, with the 10-year average sitting at 27.31. However, focusing on absolute CAPE numbers can be misleading - what matters more is where we stand relative to recent history.

Using a 3-year percentile framework provides better context. Currently, India’s CAPE sits at the 57th percentile of its 3-year rolling history - meaning current valuations are higher than 57% of observations over the past three years. For perspective, the average percentile since May 2009 has been 59.3%, suggesting today’s valuations are close to their historical norm when viewed through this lens.

Why percentiles matter more than absolute numbers

Current CAPE: 40.24
10-Year Average CAPE: 27.31
→ Appears 47% above average

BUT:

Current 3-Year Percentile: 57%
Long-term Average Percentile: 59.3%
→ Actually near historical norm

The percentile approach accounts for structural changes in market composition, earnings quality, and valuation regimes over time.

What This Means for Forward Returns:

Based on the 3-year percentile analysis of historical data since May 2009, current valuations at the 57th percentile fall within the 30-60th percentile bucket, which has historically delivered average 5-year returns of 14.89% - slightly above the overall rolling average of 13.88%.

Key Observations:

1. Near-average positioning: At the 57th percentile, current valuations sit slightly below the long-term average of 59.3%, suggesting neither extreme cheapness nor extreme expense

2. Historical context matters: The 3-year percentile approach captures that markets evolve - what was “expensive” a decade ago may differ from today’s standards

3. Return expectations: Entry points in the 30-60th percentile range have historically delivered returns of 14.89%, moderately above the 13.88% average across all periods, but well below the 15.26% achieved when entering below the 30th percentile

Note: The percentile framework intentionally focuses on relative positioning rather than absolute CAPE levels, as it provides more relevant context for investment decisions. While the absolute CAPE of 40.24 is well above its 10-year average of 27.31, the percentile ranking suggests this premium is not unprecedented in recent years.

What This Means for Investors

For new investors: Set realistic return expectations when entering near average valuations. While 13-15% annual returns represent solid wealth creation, they may fall short of the 15%+ returns available during cheaper market periods (below 30th percentile).

For existing investors: Don’t panic but understand that “time in the market” works better when combined with reasonable entry valuations. Very high starting valuations can take years to normalize.

For everyone: This isn’t a crystal ball for market timing. The research shows clear patterns but significant variability remains. Even in expensive markets, some investors still achieve good returns.

Put Your Eyes to the Test

Understanding valuations is one thing—spotting them in the wild is another. Think you can tell what is cheap or expensive?

1. We show you a market snapshot
2. You guess the CAPE bucket (Most Attractive / Reasonable / Elevated / Extreme)
3. We reveal the actual CAPE, the percentile, and the 5-year return that followed

Warning: may cause mild embarrassment and healthier expectations.