Going by this, Indian stocks are not at all attractive!

Aug 1, 2015

In this issue:
» How big of an influence do FIIs have on Indian stocks?
» Can Americans live without debt?
» Roundup on markets

 Chart of the day
The Indian markets have been quite volatile in recent months. The BSE-Sensex, for instance, has broadly been hovering between the 27K to 28K levels for a while now. Earnings of India Inc. have been disappointing. And in the process, the market has seemingly become expensive as the earnings multiples have expanded.

This makes it difficult to gauge the outlook from a short to medium term perspective...

There are various views circulating around. On one side, the view is that the stretched balance sheets will make it difficult for the investment cycle to pick up; and that market expectations will not be met.

On the other, views are that as and when the cycle picks up, India Inc will be well prepared (considering the underutilized capacities) to meet the demand. This is measured by the low asset turnover and dull margin scenario. These have led to contracting return ratios over time, something which we had written about in one of our 5-Minute Wrap up editions in the month of March this year. These are nevertheless facts that indicate a high probability of profit scenario improving going forward. And it would be safe to assume that this is why the markets continue to maintain high expectations, moving sideways despite the expanding valuations.

Having said that, relative to global markets, India is not cheap! An article put up on the website thisismoney.co.uk towards the end of last year did indicate that India was (and should still be) amongst the most expensive markets globally - based on various metrics such as P/E ratio, Price to book value (P/BV) and the CAPE (cyclically adjusted price to earnings) ratio.

Keeping this in mind, we thought it would be a good idea to put things in a different perspective. That of gauging market attractiveness based on the proportion of Indian stocks trading at various P/BVs over the past fifteen years.

For this exercise, we pulled out a list of constituents of the BSE-500, BSE-Midcap and BSE-Smallcap indices. Then we took their year end (as of 31st March each year) P/BV data - this measure has been taken to eliminate the cyclicality factor of the economy - and put the stocks in various buckets; i.e. P/BV of less than 1, 1 to 2, 2 to 3, 3 to 6 and more than 6.

For example, out of 600 stocks, if 200 were trading in the range of 2 to 3 times book value, then the proportion of this bucket would be 33% (only for this year). If 50 stocks were above the 6 times PBV value, then the proportion of this bucket would be 8.3%, and so on.

The following chart is the result of the same...

Indian stocks: An unattractive asset class at present?

This chart is a good indicator of the overall attractiveness of the market over the years. What is interesting to point out that using this perspective, the overall attractiveness scenario is very similar to what it was back in 2007 and early 2008. The proportion of stocks below 3x book value is the least at the moment (over this period) while the proportion of stocks trading 6 times and above is the highest!

Many studies (including those done by us overtime) of Indian and global markets have shown that the long term payoffs are the highest when the broader markets are attractive. Going by the data points above, it only indicates that the current environment does not seem to be one that is conducive for a broad based upsurge; thereby only enhancing the need to be very picky when it comes to making investment decisions, irrespective of which direction the economy turns.

Would you be willing to sit it out till the time the market cools down, or do you have an alternate approach of investing in such a market? Let us know your comments or share your views in the Equitymaster Club.

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Have you ever thought of who the biggest shareholders in all Indian companies put together are? That the promoters will own the biggest chunk of shares is obvious. They own about 51% of the universe of companies listed on the Bombay Stock Exchange (BSE). But how do things look as far as the rest of the shares are concerned? A recent Value Research study paints in interesting picture on this front.

Who is the largest non-promoter holder in India?
Data source: Value Research

As today's chart of the day shows, foreign institutional investors (FIIs) own a whopping 40% of the non-promoter portion (called free float) of Indian listed companies. Not surprisingly, their decisions to buy and sell dominate market movements.

Retail investors on the other hand own 33%, which is far lesser than their aggregate holding in many other countries as per the report cited. Domestic institutional investors (DIIs) like insurance companies, banks and mutual funds come next with a 20% holding. However, on an individual level, it is not an FII but a DII that comes in as the largest public shareholder in Indian equities by far. Yes, with an about 8% holding in the free float of Indian listed companies, LIC plays an overbearing role as the biggest non-promoter shareholder in the country.

That government debt in the US has swelled to unsustainable levels in the US is a fact well known. Since the 2008 global crisis, the US Fed has tried to bolster US' economy through massive stimulus programs. Rather than help US come out of the slump, these programs have only piled on the debt on the government's books. But government debt is not the only worrying factor for the US. Household debt is a problem too. Indeed, as per an article on zerohedge.com, a brand new survey stated that 7 out of every 10 Americans believe that debt is a necessary part of their lives.

And this indebtedness is something that starts as early as in college. Inorder to get into the best possible schools, students go in for debt to pay costs. But there is a risk attached to it. The assumption is that the best schools will guarantee good jobs. But that is precisely the problem that the US is facing. Jobs are not easy to come by. Meanwhile, the debt has to be repaid. Here is another statistic. Right now, there are around 40 m Americans that are paying off student loan debt. And for many of them, they will have to keep paying till they become senior citizens.

The other kind of debt haunting America is credit card debt. According to zerohedge.com, the average US household that has at least one credit card has approximately US$ 15,950 in credit card debt. In short, it appears that most US citizens will send their entire lives just paying off debt. Unless something revolutionary happens that will take the US economy to the next level. But that looks quite unlikely what with the Fed's focus on only money printing and pretty much nothing else.

The performance of global markets this week was a mixed bag. The major event of the week was of course the US Fed meet which ended on expected lines with no change in policy. The Fed also did not state explicitly if they would start raising interest rates in September. The US markets however, did not celebrate the news as economic data continues to remain mixed. There is confusion among economists about the strength of the US economic recovery. The Dow ended higher by 0.7% for the week.

European markets continued to remain volatile as concerns surrounding the viability of the Greece bailout deal weighed on sentiment. It is becoming increasingly clear that the deal may not work in its present form and the IMF has already refused to participate.

The biggest losers this week were the Chinese markets. The Chinese government's desperate measures to support the stock markets are proving unviable. The impact was felt on a few other Asian markets as well. However, the Indian markets managed to overcome the negative global sentiments and closed flat for the week.

Performance during the week ended 31 July, 2015
Data source: Yahoo Finance

 Weekend investing mantra
"People who habitually purchase common stocks at more than about 20 times their average earnings are likely to lose considerable money in the long run." - Benjamin Graham & David Dodd

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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2 Responses to "Going by this, Indian stocks are not at all attractive!"


Aug 2, 2015

The idea of comparison of P/BV ratios for last 15 years was new to me. At present levels, the markets indeed don't seem conducive for large investments. Thanks for presenting me another point of view.

Like (1)

Chandravadan Ajmera

Aug 1, 2015

I fully agree with the author. Market is definitely expensive at this stage. There are all the chances for market to correct by 20%

Like (2)
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