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Is India Over-priced?

That is a question that is on everyone's minds, after the bellwether index, BSE Sensex hit its all-time high. A euphoric rise is followed by a 'correction'. And so everyone believes.

I believe that an investor with an eye on the long-term, should spend his time and energy in understanding the big-picture numbers, rather than short-term gyrations that is never under his control. The markets may be foolish in the short run...but it has the good habit of correcting itself in the long run. And numbers get their due.

In this post, I will take a look at the question from a fundamental perspective. I will not predict the Sensex level, which is something best left to the TV channels and the 'experts'. I shall present my perspective of the numbers as they stand today.

The table juxtaposes and compares major Asian countries on key fundamental parameters like EPS growth, the P/E multiple, Return on Equity and Return on Capital Employed. Finally, I have added the Price-to-Earnings-to-Growth (PEG) ratio to get a sense of where the respective equity markets stand in relation to their expected growth.

First on the EPS growth. India is expected to post the highest growth rate in the pack. Consistently high growth rates have been a key factor in the re-rating of the Indian markets over the past 3/4 years. The high double digit growth rate is expected to continue going forward too. Structurally the economy is on sound footing. Increasing capacity utilization across industries, increased investment, favorable demographics and emergence of the middle class have all contributed to the upturn in the Indian economy. Increasing openness in the economy has attracted foreign investment (portfolio and FDI). With these factors expected to remain in place over the foreseeable future, it doesn't seem outlandish for India to achieve the expected EPS numbers.

Next on the Return Ratios. India again emerges at the top of the pack on ROE and ROCE. High ROE and ROCE characterize strong businesses with a reasonably strong moat and sustainable competitive advantage. All the 'Buffet' factors seems loaded in favor of India. While there might be some moderation in growth due to the high base effect, the fundamental drivers of ROE are firmly in place.

Third on P/E multiples. India - which is expected to post the strongest growth rate - is valued lower than Malaysia, which is expected to grow modestly. While this points to the possible over-valuation in Malaysia, its still relatively easy to see India's relative attractiveness on the P/E metric. Only Korea and Thailand trade at lower multiples, but they are also expected to grow slower than India.

Finally, on the PEG metric, India is the most attractive in the lot. A PEG of 0.53 is very attractive especially considering the fact that India has the best fundamentals of the lot. India ranks very highly on corporate governance too.

A mixture of high corporate governance standards, strong fundamentals, and attractive valuations leads me to believe that the Indian markets are not over-priced, as much as people would like to think. The rise in the Sensex has been accompanied by EPS growth, which in turn is driven by strong Sales growth. In fact, given its fundamentals, I wouldn't be too surprised if the Indian markets eventually trade at a premium to its Asian peers. While there is still some way to go before reaching that point, I think that India is well on its way to get there.

So what can a small investor expect from the equity markets going forward? FIIs will come and go. There will be fears of the 'Yen Carry Trade' and the disastrous effects that the unwinding of these positions have on financial markets. The eventual direction of the market is up...but this will most definitely be interspersed with corrections every now and then. People will get scared and sell, thinking that the world has come to an end at every fall in the markets.

But the intelligent investor stays on...evaluating the macro scenario periodically to ensure that the fundamentals haven't changed for the worse. As long as the fundamentals are intact, the investor should stay put...but once the underlying premise on which the decision was made changes...well...the investor would do well to remember the adage..

"When the conditions change...I change my opinion. What do you do Sir?"

Comments

Agreed that corrections ensure that in the long run the market prices are correct. But The Indian stock market doesnt work on fundamentals. short term over valuations will continue to happen. Most of the non-institutional buying is based on the market trends. Infact I feel right now the market is over priced.But its better to let the market forces ensure tht the correction happens.The issue is getting in more non-institutional investments, coz the potential is huge.
Anonymous said…
good logic n well written dude...ur making an interestin point ..i disagree to wat aditya just said that the market is not moving on fundamentals as a minority % of the stocks are rigged i agree...but the majority is very evident from the growth numbers the companies are showing..keep up the good work mate...

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