The biggest issue in the Indian market today is its valuation.
Money from foreign institutional investors is once again flooding in, with $1.5 billion worth of net inflows in April. But a recent Citigroup report by Chris Leung, Marcus Rosgen and Elaine Chu points out that India is the most expensive market in the Asia Pacific-ex-Japan region, in terms of three of its valuation parameters: price/earnings, price/book value and dividend yield.
It’s the second-most expensive market in terms of EV/Ebitda (enterprise value/earnings before interest, tax, depreciation and amortization).
However, for diehard optimists, there’s some hope—the Indian market is somewhere in the middle when valued on an EV/sales basis and, very importantly, its return on equity is second only to Indonesia’s.
With a consensus earnings estimate of Rs830 for the 30 Sensex stocks for FY08, the Sensex, at 14,000, trades at a forward price-earnings ratio of 16.8. And with consensus earnings growth for these stocks at 16%, the index looks more than fairly valued.
But, it has long been argued that while Indian stocks are expensive, that’s because the growth in earnings per share for Indian companies is also high. The other argument is that the higher prices are justified by the high return on equity.
Fair enough, but as the report points out, earnings growth is higher in Indonesia and in Taiwan, markets that have much lower price-earnings ratios. And as Indian companies embark on capacity expansion, currently steep returns on equity are bound to fall. So how does one make the case for Indian stocks?
One method is to push out the earnings growth another year, to 2008.
On 2008 estimated earnings, the Indian market is less expensive than Hong Kong, Singapore, Australia and Malaysia.
Unfortunately, the Citigroup report says that the Asian region as a whole is becoming much more expensive in terms of its historical averages. It points out, “On a trailing P/E basis, Asia ex-Japan is now trading at the steepest premium since 1990 vs MSCI AC World.”
So why is money flowing into India? One reason is that, with the underperformance by the Indian market this year, its premium relative to other markets in the region has dropped. The other reason is the decline in the value of the US dollar, which makes investing in non-dollar assets more lucrative.
Everything depends on liquidity. Very recently, there has been a noticeable decline in inflows to both Asian country funds and to global emerging market (GEM) funds.
According to EPFR Global, which collates fund-flow data from around the world, “In addition to a resurgence of risk aversion, a six-week run that saw GEM funds chalk up collective portfolio performance gains of over 12% has raised fresh questions about valuations...”