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In the short term, markets are driven by various factors—momentum, liquidity, sentiment, technicalities, fundamentals, and others. But in the long term, fundamentals prevail. In the long term, stock price is a slave to earnings and market capitalization (market cap) is a function of value created.

The stock market is a brutal place. Companies with large turnovers can quote at a lower market cap than that of small companies with good profits. And companies with big projects can quote at lower values than companies with brainpower.

Today, interesting observations can be seen in the market cap of the Indian stock market.

n The information technology (IT) sector accounts for little more than 13% of the total market cap; the oil and gas sector accounts for about 11.5%; banking and financial services contributes little more than 14%; and the fast-moving consumer goods (FMCG) sector accounts for about 10%. These sectors’ contribution to market cap is many times more than their respective contribution to the gross domestic product (GDP). Sectors such as real estate, construction and textiles—which provide high employment—individually contribute less than 1% to the total market cap.

-The IT sector is valued at more than six times the market cap of the cement sector, more than three times the market cap of the power utility sector, little above 2.5 times that of the pharma sector, twice that of automobiles and auto components (including global presence), a little under twice of metals and mining, and about 1.25 times the FMCG sector.

-If the IT sector has to give a 15% annualized return to investors, it has to create an equivalent of the entire two-wheeler industry’s value in just 11 months, or that of the three state-owned refineries’ value in just 8 months, or about 2.75 times the value of the real estate sector’s market cap in a year.

-The pharma sector—at about $54 billion market cap—is now bigger than the top three telecom companies ($35 billion). It is also bigger than the power companies (market cap $47 billion). It is 6.5 times bigger than the $8.3 billion-strong real estate companies. It is 5.75 times bigger than the media sector whose market cap is $9.4 billion.

-The banking and financial services sector provides an interesting transition. Private sector banks, at $91 billion market cap, are more than twice the $40 billion market cap of public sector banks and financial institutions (FIs). At $16 billion market cap, the non-banking finance companies (NBFCs) are 39% of public sector banks and FIs. Alternatively, private sector banks quote at a market cap higher than advances portfolio (which is funded by leverage), and on the other hand, public sector banks quote at a market cap lower than the net worth, or, with a little imagination, lower than the market value of their corporate office building. Public sector banks, which probably come in contact with as many customers as FMCG companies, are valued at little more than one-third of that sector even though far more capital has been invested into them.

-The metal and mining sector, which includes some of the largest reserves of coal, iron ore, zinc and bauxite, is valued at $71 billion. This is just a shade above India’s largest IT company’s market cap. Here, it is important to note that currency depreciation creates a positive momentum for both these sectors.

-The engineering sector is valued at $36 billion—little more than half the market cap of the largest IT company but less than the market cap of the largest FMCG company. It is also almost double the market cap of the largest pharma company. No wonder students no longer prefer the real engineering courses.

-Real estate prices have gone up in multiples in the past decade. The sector receives the highest allocation of India’s savings since most investors have made money in real estate. It probably gives the highest employment in India if construction workers are included. But at $8.3 billion, its market cap pales against that of the largest housing finance company ($20 billion). It is also just a fraction of the market caps of the biggest IT, banking and FMCG companies. At least in the stock market, selling soaps or tablets is more valued than selling flats.

-The FMCG sector is valued at $111 billion. It is the only sector which generates return on equity (RoE) in excess of 50%, and has the highest price-earnings (P-E) or price-to-book (PB) valuations. What’s surprising is that the IT sector, which generates a RoE of 33%, trades at a P-E multiple of 20 and PB value of 5.9, whereas the automobile sector (mainly two- and four-wheelers) generates a similar RoE of 29% but trades at a P-E of 14 and PB value of 3.8. It seems that the old economy is less popular than the new economy in the stock market.

-The retail sector (brick and mortar as well as e-commerce) trades at a significant discount to what the new economy e-commerce companies are valued at in the private market. E-commerce companies may end up re-rating the entire retail sector in the public market at some point.

Markets continue to have cycles of undervaluation, fair value and overvaluation. Maximum money is made when one can pick up an undervalued stock just as it is moving towards fair valuation or overvaluation. The top-down analysis made above gives food for thought.

End note: Globally, four of the top 10 listed profitable companies are Chinese banks. Four of the top 10 most valued banks in the world are Chinese. Today belongs to China but let’s hope that tomorrow will be ours.

Nilesh Shah is managing director and chief executive officer, Axis Capital.

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