Indian markets attractive on Buffett's favourite indicator - Chart Of The Day 2 July 2015 - Equitymaster

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Indian markets attractive on Buffett's favourite indicator
Jul 2, 2015

When it comes to analyzing the risk reward ratio some metrics are really helpful. For example, the market cap to GDP ratio, widely popularized by Warren Buffett, is perhaps the best gauge to judge the relative attractiveness of stock markets. The ratio is calculated by dividing the market cap of all the listed securities on an exchange with the GDP of that country. If the ratio is greater than 1x (or 100%) markets are overvalued and vice versa. A ratio of close to 1x indicates markets are fairly valued.

As seen in today's chart the market cap to GDP ratio of the US markets is highest at 143% while India ranks last in the list at 77%. This indicates that the Indian markets are cheapest at this juncture based on the market cap to GDP metric.

An interesting case in point over here is the rivalry between two Asian nations namely India and China. Until recently China was more attractive than India with a lower ratio. However, since March 2014 the Shanghai stock market is up 150% as against a 27% odd rise in the BSE-Sensex during the same period. As a result, the market cap to GDP ratio of China has risen considerably.

While this metric gives a reasonable indication whether a market is over/under valued there are other parameters (P/E ratio etc) that investors must consider to get a sense of market valuations. Cash levels of noted investors, general activity in IPO markets etc are other indicators that can help gauge market sentiments. However, investors should remember that money is not made by simply buying the markets (read index). Real money is made by buying companies at attractive prices and hence the ultimate focus should be on indentifying fundamentally sound companies at cheap valuations.

Data Source: Business Standard, Bloomberg, World Bank
SK$= South Korea

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