Indian stocks in favour despite high valuations

Global fund managers are still upbeat on India despite higher valuations, and say it is one of the strongest structural stories among emerging markets


The MSCI India index trades at 20.74 times the one-year forward estimated earnings. Photo: Hemant Mishra/Mint
The MSCI India index trades at 20.74 times the one-year forward estimated earnings. Photo: Hemant Mishra/Mint

Mumbai: While valuations of Indian stocks may appear expensive, the premium at which they trade relative to their emerging markets peers is still much lower than the more than 100% seen in early 2008.

Global fund managers are still upbeat on India despite higher valuations, and say it is one of the strongest structural stories among emerging markets.

The MSCI India index trades at 20.74 times the one-year forward estimated earnings. The price to earnings multiple (P/E) is at a 61.34% premium to the MSCI Emerging Markets index, which trades at 12.85 times its year-ahead earnings. Earlier this month, this premium stood at 62.99%, the highest since February last year, when it was at 69.54%.

However, the current premium to emerging markets is much lower than the levels witnessed in early 2008, indicating the local market is nowhere near frothy valuations.

India’s valuation premium over peers rises, but why are DIIs selling?

“Indian equities typically always look a bit expensive compared to other countries and after the recent run, valuation is on the high side,” Hertta Alava, director of emerging market funds at FIM Asset Management Ltd, said in an emailed response to a query from Helsinki.

“However, I’m not too worried. India is my long-term favourite among the big emerging economies,” said Alava, who manages €350 million in emerging market assets.

The National Stock Exchange’s benchmark Nifty index rallied to a record closing high of 9,160.05 points last week, after Prime Minister Narendra Modi’s Bharatiya Janata Party (BJP) pulled off a resounding victory in the Uttar Pradesh assembly elections.

Investors bet on stronger and bolder reforms ahead on expectations that this win would set the stage for continued political stability at the centre, ignoring headwinds such as continuing earnings downgrades and a weak recovery in private investment demand.

Nifty in March 2015 and now: What has changed?

Even when one looks at the market-capitalization-to-GDP ratio, Indian shares do not seem to be in the bubble zone. The ratio stands at 78.9%, albeit higher than in recent times, but still much lower than the over-100% levels in early 2008.

A significant earnings recovery is not expected before the last quarter of the current calendar year, as the implementation of the goods and services tax (GST), which is scheduled for 1 July, may hurt earnings in the near term.

The silver lining, however, is that the impact of demonetization on corporate earnings may have been overestimated as the December quarter earnings data shows.

Among the 50 members of the Nifty index, 28 companies beat earnings estimates for the December quarter and 22 missed them.

In a report released on 28 February, Credit Suisse said investors are focused on emerging markets this year, particularly India and some other Asia-Pacific nations.

The report said that the overall Asia-Pacific region drew the greatest interest—24% net demand, down from the last two years, but enough to top the 2017 list.

This year’s top three regional strategies were Asia Pacific, emerging markets and India, clocking in at 24%, 22% and 19% net demand, respectively, the report said.

Christopher Wood, managing director of CLSA, said that while India remains the most interesting long-term equity story in Asia and among emerging markets in general, there is no sign yet of a new investment cycle in India.

“The other point as regards the Indian stock market is the continuing evidence of domestic equity mutual fund flows. Foreigners began 2017 looking for reasons to sell India, not buy it. But capitulation has now begun, and the UP election result will have further accelerated that capitulation,” Wood said in his newsletter “Greed & Fear” on 16 March.

While foreign institutional investors (FIIs) were net sellers of Indian shares in January, they lapped up the asset class in the subsequent months. FIIs have pumped in a net $3.8 billion in Indian shares, the second-highest among its peers in emerging markets and Asia after South Korea.

Indian markets will continue to do well in an environment where emerging-market currencies, including the Indian rupee, are strengthening, said Darshan Bhatt, managing partner at Glovista Investments Llc in New Jersey.

On Friday, the rupee closed at 65.48 against the dollar. It has strengthened 5.17% from a record low of 68.86 on 24 November.

“Within broader emerging markets, India provides a strong growth story with high visibility for global investors. The greater clarity on policy front carries the potential for further strengthening of growth,” Bhatt said, adding that he continues to be overweight India within both the emerging market and Asian contexts.

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