The ratio of market capitalization to gross domestic product (GDP) often is cited as an indication of how cheap or expensive a market is.

A recent report by Citigroup Inc.’s chief Asia strategist, Markus Rosgen, says China today enjoys a market cap-GDP ratio of 123%—slightly lower than the 131% reached by the US in 2000, at the height of the dotcom boom. During the heyday of the Japanese bubble, that country’s market cap-GDP ratio reached 150%.

In India, market cap is now around $1.5 trillion (Rs59.4 trillion), while GDP in fiscal 2007 was $945 billion at the current exchange rate. That gets a market cap to GDP figure of 158%, well into bubble territory. Even if we assume a nominal growth rate of 13.5% (8.5% plus inflation of 5%), GDP for fiscal 2008 would be $1.07 trillion and the market cap-fiscal 2008 GDP would be 144%. But there are several problems with the ratio.

First, the calculations vary widely. For instance, Investopedia Ulc gives a market cap-GDP ratio of 153% for the US in 2000. Others peg it even higher. Secondly, it doesn’t adjust for new firms coming into the market and adding to market cap, or for companies switching to equity from debt as a means of funding. And it doesn’t take into account the stage of development of the markets.

The Citigroup report attempts to correct the last shortcoming by considering the market cap-GDP ratio at the same stage of development. They take China’s current per capita income—$2,500—and consider where the Japanese and US markets were when their per capita GDP was at that level. The numbers are revealing. In 1956, when per capita income was $2,601, the price-earnings (P-E) multiple of the S&P index was 13 and the market cap-GDP ratio was 49%. Japan’s per capita income was $2,838 in 1972 and the P-E multiple for its Nikkei index was 22 times, while its market cap-GDP ratio was 52%.

China, on the other hand, with a current per capita income of $2,560, has a P-E multiple of 50 and a market cap-GDP ratio of 123%.

What about India? The Central Statistical Organization (CSO) estimates for fiscal 2007 show a per capita income of Rs29,382, or around $742. Assuming a nominal growth of 13.5%, the per capita income for fiscal 2008 will be $842. The Sensex currently trades at a P-E multiple of 26 and, as mentioned above, the market cap-GDP ratio is even higher than China’s.

Clearly, by the measures used by Citigroup to prove that the Chinese market is overvalued, the Indian market, too, is grossly overpriced.

But is 2007 comparable with 1956 or 1972? Globalization and the free flow of capital have made a big difference since the 1990s. Also, US growth between 1953 and 1971 averaged 3.6%, while Japan’s growth in the 1970s was an average 5%. China and India’s current growth rates are much higher. However, while Japan’s GDP growth rate averaged 9% between 1953 and 1965, the Nikkei 225 went up by around 300% in those 12 years. That’s less than the rise of the Sensex in the last four years.

There’s little doubt that, compute it whichever way you like, there’s no escaping the fact that it’s abundant liquidity that is responsible for current stock valuations. With liquidity coming down, valuations will follow.

Rolta on a roll

Rolta India Ltd’s shares jumped around 7% on Monday, regaining about one-third of the losses they incurred after hitting a 52-week high earlier this month. The company’s share price had corrected as much as 16% since it closed at a high of Rs757.7 on 6 November, performing much worse than the languishing CNX IT index during the period. But the underperformance during the last couple of weeks has hardly made a dent in Rolta’s overall performance and the stock has beaten the CNX IT index by 232% since January 2007.

Rolta’s stellar performance this year prompted Macquarie Research to position the stock as “More L&T than Infosys." The stock has a high correlation with engineering and construction stocks simply because much of its business comes from the infrastructure space. Besides, only about 24% of the company’s revenues are US dollar-denominated, much of which gets a natural hedge since the company spends nearly 88% of that amount in the same currency. Thus, rupee appreciation, the main reason information technology (IT) shares have underperformed, hasn’t impacted the firm. Consolidated net profit rose as much as 44% last quarter on the back of 43% increase in revenues— much higher than the growth rates managed by top-tier IT companies.

Rolta entered into a joint venture (JV) with Thales Group of France last year, which is expected to help the company gain further inroads into the defence sector. The company’s top client is already the ministry of defence in India, and Thales’ expertise in mission critical information systems for the defence, aerospace and security markets will increase its share of business from the Indian government.

Macquarie estimates that the JV has enhanced the addressable market within the Indian defence space by 30% to Rs40,000 crore.

It expects the JV to report revenues of Rs120 crore in the next financial year, ending June 2009. In the year till June 2008, Rolta is expected to report revenues of about Rs1,000 crore, which means the JV could add about 12% to the firm’s top line in fiscal 2009. India’s infrastructure story is strong and is expected to help valuations, but there could be a correction.

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