Where does India stand on valuation ground? - The 5 Minute WrapUp by Equitymaster
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Where does India stand on valuation ground?

Mar 9, 2015

In this issue:
» This could be the biggest challenge to 'Make In India' drive
» Pearls of wisdom from Buffett's latest annual letter to shareholders
» Market roundup
» ...and more!

  Chart of the day
We have been drawing your attention towards how frothy valuations in the Indian equity markets are a matter of concern despite all the optimism about reforms and economy. But those who wish to believe otherwise will find no lack of counterarguments either. The recent one that we came across was the data on market cap to GDP ratio. Now we could not help taking notice of it as the statistics that we are referring to here is a favorite of investing legend Mr. Warren Buffett when it comes to gauging valuations. One must note that market cap to GDP ratio, unless it exceeds 1, is not considered a reason for concern.

As per the data complied by Hindu Business Line, India's market cap to GDP ratio currently stands at 0.83. Even emerging economies like Thailand and the Phillipines have higher ratios than India. Further, developed economies like Japan, Singapore and US are above the crucial mark of 1. This may make the ratio seem deceptively harmless and tempt you to believe that there is still significant room to make money in Indian equity markets.

Are Indian markets reasonably valued?

However, before you buy that argument, please note that there is more to it than meets the eye.

First of all, the data considers the GDP as per the revised standards One must note that the new method used by the Government forecasts GDP growth of 7.4% in FY 15 and suggests last fiscal GDP growth at 6.9%. While this seems a little high for India where triggers are yet to strike, what makes it even more fishy is the fact that the corresponding numbers as per prior methodology were 4.7% and 5.5% .

Now this is no insignificant revision, but a change enough to make a struggling nation look like one of the fastest growing economies. And it is not just us. Even the stakeholders and watchdogs are finding this new method difficult to digest.

As per the Survey by Assocham that included 189 CEOs and CFOs, around 76% believe that the revised GDP growth is too good to be realistic. As much as Government wants us to believe that things are improving, it is yet to be reflected in the earnings and production data. And even if we buy the reform story, it will take considerable time before the benefits start getting reflected in the actual growth numbers. It seems even the RBI does not trust the new projections to formulate monetary policies. It has questioned the Government regarding the assumptions that make the economic picture look brighter than it actually is.

This certainly is a reason good enough for investors to be wary. If you plug the GDP numbers as per the old method into the formula, the market cap to GDP ratio for India stands well above 1 (versus 10 year average ratio of 0.78)!

This suggests that India could be placed at higher ground on valuations. The last time the score went past 1 was 2007-08. And what followed is something no retail investor would like to be reminded of.

It's not just absolute comparison. Even on a relative basis (across economies), one must understand that comparison might not be very relevant and meaningful. This is because economies differ significantly in terms of stages of growth cycle and maturity of the stock markets. For instance, in this case, the comparison of India with US economy does not make much sense. The latter is a more mature, global and capitalistic economy with a large part of its businesses listed. On the other hand, India is more about the small entrepreneur, unorganized sector and unlisted companies. All of which add to GDP but not to the total market cap! Even different inflation levels for these economies does not make the comparison on this parameter meaningful.

This is not to suggest that Indian markets are overheated and to be completely avoided. But they definitely do not seem as reasonably valued as the statistics suggest. This was just one measure that makes Indian markets look favorable. There might be many more. Hence, whenever you come across such arguments, do not just stop at the superficial analysis. Remember, the devil lies in the details.

Do you think that Indian stock markets might not be reasonably valued currently, irrespective of what the data suggests? Let us know your comments or share your views in the Equitymaster Club.

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While markets may seem overheated at the moment, we believe that this is truly the time to set your vision on the long term growth story of India. Let us explain why. If you stay focused on the long term big picture then the short term stock price volatility will stop bothering you and sabotaging your investing decisions. Most people think stocks are risky because of exactly this fixation with stock price volatility. And they keep losing money also for this very same reason.

In his most recent annual letter to shareholders, legendary investor Warren Buffett shatters some very common myths about investing in stocks with some startling statistics. He mentions that during the fifty year period from 1964 to 2014, the S&P 500 generated an overall return, including reinvested dividends, of 11,196%. During this same period, the purchasing power of the US dollar dropped a staggering 87%! So say you were a US citizen back in 1964 with the choice to either invest in US businesses through stocks or to invest in fixed income securities whose values are tied to the currency. Which investment would have protected your purchasing power and generated real wealth? In that sense, which investment then would have been truly safe over the long term? It is clear that it would be equities.

Now someone may be tempted to counter question if this is held true across different periods of history. As per Buffett, this held true even in the five decade period prior to 1964. This period included the Great Depression and two world wars. And yet, equities seemed to be an investor's best bet.

So what is really safe and what is really risky? As it turns out, currency-denominated investment instruments are much riskier over the long run given the paper currency's tendency to lose value over time. Equity investments, on the other hand, are the true saviors and winners over the long term.

A quote that we recently came across on Twitter sums up what we believe here at Equitymaster. It went thus- "You will make much better investing decisions when you think in years and not weeks and months. Short term thinking paralyzes your returns."

Talking about the Indian economy, one of the big themes that the new Prime Minister presented us with was 'Make in India'. If we are able to manifest this vision, it could result in massive value unlocking for the entire nation. But there are many obstacles that we face to realize this vision. Let's get a ground reality check from one of the major Indian corporates. In an interview with Business Standard, Rajiv Bajaj, Managing Director of Bajaj Auto shares the challenges that he has been facing in India. According to him, it is easy to make in India. The big challenge is to sell in India. What does he mean?

Apparently, the company built the prototype of a quadricycle nearly three years ago. But the company is still unable to launch the new product in the country. Why? The reasons include opposition from competitors and legal battles in court. This is despite the government having cleared a policy allowing the new vehicle category. After making all the investments, if the company has to wait for years to be able to market its products, it is indeed a matter of great concern. It hurts the entrepreneurial spirit to innovate and pioneer new products and services. In our view, entrepreneurs should not only be able to make in India but also be able to easily market and sell those products in the country.

The Indian stock markets have been trading in the negative territory today. After opening on a weak note, the markets slipped further into the red in the afternoon trading session. At the time of writing, the BSE-Sensex was trading lower by 580 points, with stocks in the power and banking sector leading the losses. Barring China, Asian indices were trading in the red. The European indices were also trading weak.

 Today's investing mantra
"Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Richa Agarwal.

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2 Responses to "Where does India stand on valuation ground?"

allen peter

Mar 10, 2015

The main constraint to 'make in India' is we are not focussed on the low skill\ semi skill segment occupied by China\ Vietnam etc. This is a high volume low margins game, where others have too big starting advantage over us. High skill \ high tech is possible, but then we have an outdated education system , which the present BJP Govt has no inclination to improve


Dharmendra Kapur

Mar 9, 2015

Ms. Rich Agarwal please verify this before publishing it.
As you sow so shall you reap. Not long ago it was to be made mandatory to provide indicators on scooters manufactured in India. Rumour had it that Bajaj Scooters delayed the notification from the authorities by "managing" it with them, as Bajaj was either having trouble in modifying their assembly line or did not want to invest in this unnecessary expense. Now the junior Bajaj saheb is complaining about selling in India !!

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