There was an interesting article we came across recently in the Business Standard. The author discussed how a few bunch of factors indicate that the US stock market is way more attractive as compared to India's. Purely going by the P/E metric, the Sensex traded at a multiple of 20.8x its trailing twelve months earnings. In comparison, the Dow Jones traded at a multiple of 14.3x. These data points are at the start of this week.
The author also compared the two indices based on the Price to Equity ratio. The ratio is calculated by dividing the price to earnings multiple by the return on equity. Lower the ratio, the more attractive is the security. As of March this year, the Sensex was valued at 1.75x, twice as compared to that of the Dow Jones.
Further the author made his point of the US stocks being more attractive given that 23 of the 30 companies in the Dow Jones offered higher dividend yields when compared to the prevailing yield on the 10-year US government bond (2.16%). In comparison, none of the stocks in Sensex provide dividend yield higher than the government bond rate in India.
We however have a slightly different take on this. One key aspect to consider is that the weightage allocation among sectors of Dow Jones and Sensex is quite different. For example the oil & gas sector forms about 6.3% of the Dow Jones. Back home, the sector forms nearly 12% of the index. Further the technology & telecommunication sector forms about 14.63% & 1.77% of the Dow Jones, while it is 21.17% & 3.23% respectively in Sensex. So it would be safe to assume that comparing the valuations on the basis of P/E multiples would not be fair.
It should also be kept in mind that the return ratios of the Dow Jones players seem to be way superior as compared to that of the Sensex companies. But are they real? That is the key questions.
As you would be aware, after the global crisis in 2008, the US Federal government has kept the interest rates at close to zero levels to boost the economy. The interest rates and the bond yield rates have a direct correlation with each other and thus yield on the latter have been very low.
Not to mention that the US companies have taken advantage of this situation and have boosted their return ratios by cleaning up their balance sheets and also resorting to buybacks. As such, even in this context we believe a like to like comparison would not be meaningful. By how much and by when the interest rates will be hiked is a question we do not have the answer to. But, we do know that once they same normalizes, it would have a significant impact on the US economy.
In contrast, Indian companies have largely been struggling with excess capacities, which have taken a toll on their return ratios. Not to mention that the low commodity prices too would have impacted some of the key constituents of the index.
Please note that we are not saying that the Indian markets are attractive at the moment, but we believe it would be such factors that need to be taken into consideration when we make such comparisons.