A market bubble occurs when speculators have taken over a market. It normally starts with a genuine bull market that then spirals out of control, as greed becomes the primary sentiment of the market. More people hear that easy money is being made in the market and pile in, caution is thrown to the wind and prices run out of control.

Surprisingly, despite millions of investors being caught out and losing money in a bubble time and again, market bubbles are quite easy to recognise. The problem is really that a lot of the investors in a market bubble are new and inexperienced and those that are not have lost control of their emotions and become blinded by the prospects of easy wealth.

There are a number of signs that would tell you that a market is all a bubble. However, it takes some discipline to hold back if you feel that your friends are getting rich.

    Even fools are making money on the market and giving investment tips and advice
At the height of a bubble you find that everyone (even those people who have never been interested in money or investing) is investing in stocks and making money too.

Making money this easily can never be sustained. What is happening is that the price is being set by the last person who came into the market. Who is often an unsophisticated investor and has no idea of value, but has just heard that if he buys this stock he could double his money. Of course, once the last fool comes in, the price will start dropping.

The experienced (and cynical) brokers and bankers have the expression 'Retail investors all in,' meaning that the amount of new money flowing into the market from the public has slowed down and a fall is coming soon. Unfortunately, it is the retail investors who often bear most of the losses when a bubble bursts, mainly because they are the people with the least investment knowledge and experience and are often implement poor and have untested investment strategies or oftentimes no strategy at all.

   Everyone is coming to the market
 The number of public offers (both new and repeats) is at historic highs. All the sellers know that there is cheap and easy money to be had and are in a hurry to capitalise before the tide turns.

  P/E ratios are at historic highs Companies normally sell for 15 times earnings or 1 time sales. You can expect to pay up to 50% more or less, depending on the company, the industry, its growth prospect and the phase of the market cycle. When the P/E gets much higher than this, say 25 times or more, a bubble is forming.
If you have a chart of P/E (on a time axis) you will notice a parabolic price increase, a sure sign of a bubble. Bubbles can also be seen on the price chart but are not as pronounced as on the P/E chart.

   Profits are at historic highs
The economic cycle of high profits followed by low profits has been going on since recorded history. In fact, the first recorded bust was predicted by Joseph the dream reader, who worked for the Pharaoh of Egypt and interpreted the Pharaoh's dream as a premonition of an economic slow down on the way.

So, once profits get very high, you can be sure that at some point in the future they will go down. This is not a problem on its own, the real problem is that many investors have predicted that the big profits are here forever and when the slow down comes they realise that the companies are not worth as much as they have been paying for them.

   There is a lot of debt in the market
Margin investing is at its highest; people are mortgaging their homes to invest in the market. This is a sign that greed has taken hold and people are throwing caution to the wind.

   Value investors (like us) can't find anything to buy
And finally, there appears to be no low priced securities available to value investors, as a result they are not adding new money to the market, they have been crowded out of the market by the crowd of momentum speculators.

If you can see all or most of these factors in the market, then you can be sure that a bubble is underway. Of course you will not know for how long it will last, but at least you have enough information to protect yourself from the inevitable correction.

What about other markets?
Most of these examples apply to the stock market, but the principle is the same for other markets. For instance, in the property market you will find:

  Real estate activity (buying and selling) and new construction is at a height.

    Prices are at historic highs and yields (rents/price) at historic lows, as everyone begins to count on appreciation as the way they will make a profit.

   Banks are eager to lend at very loan to value (LTV) rates.

Is the Nigerian Stock Exchange experiencing a bubble?
  How many of your friends (or employees) are putting money into the market?

   We have seen a significant increase in new issues over the past few years, first with the banks and now the insurers are coming to the market.

    P/E ratio of the NSE is now at 43.22x. We haven't tracked it over the years, but certainly for many of the leading issues such as First Bank and Nigerian Breweries we can say that they are higher than historic.

   Profits have been growing strongly.

  Many reliable estimates say that about 18% of the market is debt financed, this would be high. We also have reports of many people (particularly in VGC) mortgaging their homes to buy shares.

  Fortunately, we are still finding sufficient fairly priced companies for us to remain active in the market.

Overall, we would say the Nigerian market is bullish and valuations are reaching historic highs, but not yet the level of excess in a full-blown bubble.