More than P/E ratio alone, you must look at whether valuations are justified. Valuations can be seen at multiple levels. You can look at valuations in terms of Sensex or Nifty. You can also look at valuations in terms of individual stocks and sectors. Don’t go by P/E ratios and P/BV ratios alone. The question is whether the P/E ratio is justified by growth. Both IT and pharma would have failed this test a year ago. Earnings and revenues were almost flattening but valuations still remained at premium levels in case of pharma. Over the next 1 year, frontline pharma companies lost over 40% of their value. The same is happening to IT. If the numbers indicate that growth is much lower than the P/E and the ROE is less than bond yields, it is time to exit the company.
There is no hard and fast rule on when you must sell out of equities. At the Nifty or Sensex level it is always better to be cautious when the P/E ratio and the P/B ratio reach the upper band of the historical chart. This problem becomes a little more acute when growth is not matching up to the P/E ratio. If you find that is the problem, as can be measured by the PEG ratio, then it can be a strong signal for you to sell and exit the stock.