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Will India catch up on its share of market cap?
Jul 4, 2012

'Irresistible' BRIC stocks! Thus screams the headlines in several business dailies today. The man making the fervent claim is none other than Jim O'Neill. Yes, the same gentleman who coined the term BRICs. The term may just be an abbreviation for top 4 emerging markets - Brazil, Russia, India and China. But over the years it has been the reference point for growth indicators and valuations. Not surprisingly, when the developed West is facing stagnation, BRICs are again the focal point. Not that these economies do not have problems of their own. But their strengths seem to far outweigh their weaknesses.

O'Neill's optimism about BRIC stocks and their potential to nearly double in 10 years stems from the valuation gap. That each of the BRIC nations has to catch up on its share of global market cap is understood. But the pace at which each one achieves this feat will determine returns for investors. Now, even the legendry Buffett has cited his favoritism for the market capitalization to GDP ratio. For India this ratio has gone up from around 93% in mid 2010 to around 120% in mid 2012. Way back in 2006 it was just 78%! That makes India's market cap to GDP multiple well above the median. Also, China which has long defeated India in terms of average long term GDP growth, has a lot more catch up to do. So putting things into perspective, a higher economic growth may not implicitly mean a higher market cap. Unlike in the US, the low penetration of financial products in emerging markets leads to a larger valuation gap in stock markets. True that Buffett's favourite yardstick is a good long term indicator. However, it can hardly be used accurately for comparative valuation across emerging economies.

Thus instead of jumping headlong into Indian equities based on the potential of BRIC stock markets, it would be worthy to separate the wheat from the chaff. We would not like to take a guess on how soon will the Indian stock markets close in on the valuation gap in terms of share of global GDP. But what we are certain about is that few fundamentally robust companies will certainly get the valuations they deserve over time. And that is the 'valuation gap' that discerning investors must watch out for.

Data Source: Goldman Sachs
Data at the end of May 2012

This Chart Of The Day was published in The 5 Minute WrapUp - Buffett's favourite multiple on Indian stocks...

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