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India has historically traded at premium multiples compared to other emerging markets. On the price to earnings (P/E) multiple, currently, it is trading at ~80% premium based on consensus estimates. India certainly has been, and is projected to be, among the fastest-growing emerging markets (EMs) (20-year growth: 7.0% real GDP). But GDP growth or even earnings growth, in and of itself, does not warrant a premium multiple or deliver higher returns. Other factors such as corporate governance and quality of underlying assets usually are the dominating factors in influencing multiples.

‘Governance Factor’ or ‘Soft Infrastructure’

If we are to take the example of a company, then one can say that by investing in a company’s equity shares an investor is effectively buying the proportionate rights to its equity cash flows into perpetuity. Where corporate governance is poor, there is a significant risk that cash flows would be diverted by controlling shareholders to the detriment of minority shareholders. As a result, the assumption of minority shareholders having a proportionate right to such a company’s cashflows is weakened.

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By logical extension, shareholder rights to the perpetual cash flows of equities would be more valuable in jurisdictions where such contractual property rights are less prone to be challenged by other parties, including the authorities, and if challenged, there exists an institutional framework that provides fair protection to the holder of such rights (equity shareholders). In countries with strong democracies, there is an adequate separation of power between well-established independent institutions such as the Judiciary, the Central Bank, and the Election Commission (EC), among others. Such an institutional framework can be thought of as the soft infrastructure of a country, which is essential to upholding property rights as well as maintaining economic and political stability.

In our view, one of the key reasons why India is consistently rated as one of the most democratic countries is due to the institutional separation of powers and the robustness of its soft infrastructure.

Compared to major EMs, the Indian market has the most heterogeneous composition at a sectoral level, and within that, it is the most diverse at the company level. For instance, Taiwan’s stock market is dominated by highly cyclical tech-hardware stocks which make up 69% of the weight. Unlike most other EMs, no single sector dominates the Indian index. India’s diversified corporate mix entails lower exposure to cyclical sectors compared to the EM average. Consequently, India’s corporate earnings have been more resilient during each of the cyclical downturns over the last two decades.

The other major difference is the level of government ownership. In India, it is a single-digit percentage whereas for EMs on average government ownership makes up for nearly 20% of the index weight. For some of the countries such as China and Russia, it is even higher. It is a well-accepted fact that government-owned companies everywhere trade at a fraction of their private peer valuations and for very good reason, as government-owned entities have social objectives that assume greater priority over investor interests.

Keeping in mind the above factors, India appropriately attracts a higher multiple relative to most other EMs.

Ramesh Mantri is CIO at White Oak Capital Management.

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