The markets are trading at life-time highs for the most of the month – March 2014. The Sensex for the last three days has now consolidated and stayed put above the 22,000-mark with relative ease. There may be many a reasons for the current up move, right from the election perspective, strong FII inflows, earnings expectations and many more. However, the bigger question for the person who wants to enter the markets at this point – is are the markets fairly valued, or are the current market valuations attractive enough or is it justified to enter the markets at current levels? And of course, finally – What are the returns that we can expect from the current levels?

To get an answer to the above questions, we first need to understand whether the markets are fairly-valued, over-valued or under-valued? And to get the answer to this question we need to understand what are long-term returns that have accrued on investment in stocks.

Let’s go back to 1990, when the BSE Sensex for the first time registered the four-digit mark of 1,000-points. It’s been almost 24 years, and now we have seen the Sensex rise to a record new high of 22,307, as on 27 March, 2014. Every journey has a story to tell, with its own twists and turns, so is the market journey in the last 24 years, which has also witnessed a lot of ‘TEJI’ AND ‘MANDIES’ – read up’s and down’s.

However, the final conclusion is that a sum of Rs 1,000 invested in the year 1990 in Sensex (or say Sensex stocks) today is worth Rs 22,300. If we compound Rs 1,000, for 24 years with an interest rate of 13.5 per cent, the amount works out to Rs 20,900. There are couple of reasons why we should consider the interest rate of 13.5 per cent. Firstly, as we compare the returns on investment with other source of investments with investments in Sensex, the market has given of 13.5 per cent return on compounding basis.

Secondly, the average returns on fixed deposits and corporate bonds over the last 20 years – which varied between 6-20 per cent, also gives a mean average of 13.50 per cent. Hence, 13.5 per cent seems a justified rate of return.

Back to our story, in the last 24 years, there were some un-expected and un-reasonable movements as well in the markets, like the galloping movements in 1992 during the Harshad Mehta Boom period wherein the market showed un-reasonable up move. The Sensex soared from 1,300 to 4,400 in the span of mere six months (up unprecendently by 238 per cent), and then crashed suddenly and settled at 1,800-odd levels. If we calculate the returns on Sensex for the period 1990-1994 on 13.5 per cent compounding interest rate. The Sensex should have been around 1,660-odd levels in 1994.

Thereafter, the next major wave came around 1999, the IT wave followed by the dot.com bubble. The Sensex zoomed to the 6,000-level in the year 2000, but then crashed heavily and finally conquered the 6,000-level in the year 2004. Now again if we calculate the returns on Sensex for the period 1990-2000 with 13.5 per cent compounding interest rate, the Sensex should have been around 3,550-odd levels in 2000, and in the year 2004 – the Sensex should be 5,900 – which eventually happened.

The next major swing was witnessed in the period 2006-to-early 2008, wherein the Sensex from 7,900-odd levels skyrocketed to 21,000-level in January 2008. The markets gained a whopping 165 per cent in a matter of mere 24 months – this was completed un-reasonable – the markets were overheated and heavily over-rated during the so-called realty boom rally. For the year 2008, the mean valuation for Sensex as per the 13.5 per cent compounding rate of interest was 9,700.

Now wonder, the markets cracked significantly in the back-drop of US sub-prime crisis, and fell straight to a low of 9,647 (Sensex). Thereafter, in the last five years from 2009-2013, the market have tried to stabilize between 15,000 and 21,000.

As per our calculation and belief, with the traditional 13.5 percent compounding rate of returns the Sensex valuation for the year 2014 – stands around 21,000-level. So today at 22,000-odd levels, the BSE Sensex valuation seems justified and fairly valued. On an average the market should trade between 15 per cent (plus and minus) of the 21,000-level – which gives us a range of 17,800-24,100. Any aggressive move above or below these levels make the valuations either over-valued or under-valued.