Has the Indian Stock Market become Cheap?

Dec 31, 2011

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
Over the course of 2011, the Indian stock market has performed poorly in the face of a global economic crisis, and a slowdown in domestic economic prospects. Abroad, the debt crises in Europe and America have taken their toll on the stock market, and at home, lower growth, corruption scandals, and the falling rupee have done the same.

The numbers confirm the poor performance of the stock market. Despite the problems facing Western economies, their stock markets have significantly outperformed Indian stock markets. In 2011, the S&P 500 in the US has seen roughly no change. The FTSE 100 in the UK is down by 6%. The BSE-Sensex here at home is down a whopping 24% in 2011.---------------------------------------- Have an enriching Saturday! ----------------------------------------

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The first thing that is likely to come to our mind upon seeing these numbers is that the BSE Sensex must be cheap. Thus, it is a good time to buy. After all, the US and the UK have seen little to no growth this year, and their markets have had little overall movement this year. In contrast, India has seen growth at around 7%, and suffered a stock market fall of 24%. Clearly this is a no brainer.

Unfortunately, things are never that simple. Let's examine some more numbers to get a clearer picture. The price to earnings ratio measures the stock price relative to the underlying earnings of the company. We can look at the PE ratio to get an idea of how much we are paying for a given level of earnings. Higher PE ratios imply that the market is more expensive.

Even though the BSE Sensex has fallen 24% this year, its PE ratio is still higher than the S&P 500 and the FTSE. The Sensex has a PE ratio of 17, while this figure is 14 for the S&P 500 and 10 for the FTSE 100. By this measure, the Indian stock market is the most expensive out of the three.

Let's consider the PE ratio in a bit more detail. Imagine we have a choice of two investments. First, we can invest our money in a fixed deposit and earn 10% guaranteed. Second, we can invest in the Sensex at a PE ratio of 17. A PE ratio of 17 means implies an earnings yield of approximately 6%. If we assume that earnings for companies in the Sensex will grow by 8% next year (this was the growth figure for 2011), then we can expect an overall return of 14%.

Let's go back to our two choices. We can earn a guaranteed return of 10%, or an expected return of 14% but with risk of loss involved. At these levels, chances are many investors will prefer the guaranteed return of 10%. Maybe when the expected return on the stock market is closer to 20%, it would be much more attractive.

Despite the large falls in the Indian stock market this year, it does not mean they are cheap. A closer look at the numbers reveals that the Indian market is still expensive relative to foreign markets, and that a fixed deposit is probably a better investment. Of course, it does not mean that certain individual stocks are not underpriced, but more that the market is a whole is not underpriced at this level.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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