Stock rally: India’s youth bulge could support higher valuations | Mint

Stock rally: India’s youth bulge could support higher valuations

Listed firms that show steeper upward curves tend to have higher profit-earnings (PE) ratios, with buyers rushing in well ahead of profit upswells. (iStock)
Listed firms that show steeper upward curves tend to have higher profit-earnings (PE) ratios, with buyers rushing in well ahead of profit upswells. (iStock)

Summary

  • Various factors have powered Indian stocks upwards and corporate earnings must keep up for a sustainable surge even if longer investment horizons start supporting larger PE ratios. It’s plausible.

In big ways and small, the meta-narrative behind India’s economic rise and stock market boom has been falling into place ever since the country began to pay market economics more than academic attention after the Cold War ended in a Soviet loss and US victory. Bulls of the current bull run may display a recency bias in the inspiration they draw, but much of their optimism—as reflected in the BSE Sensex rising above 69,653 on Wednesday—is valid. Foreign institutional investors are back in action as buyers; their dithering in 2022 after yield gaps with safe US debt got squeezed now seems like old hat. An enlarged base of retail investors has held indices up, even as India’s economy has recovered from its covid contraction robustly enough to keep up a relatively pacy trajectory. After output lost to the pandemic was plugged in 2021-22, official GDP growth was placed at 7.2% in 2022-23, a rate that was beaten in the first half of 2023-24. This not only contrasts with India’s dismal pre-pandemic slowdown, corporate profits have upped their share in the overall income pie as well. And if Sunday’s state-election results boosted expectations of domestic policy stability under a Narendra Modi administration beyond 2024, signs have also grown steadily of US-led global geopolitics working in India’s favour.

As bursts of exuberance can lead to asset inflation on stock exchanges, typically fed by a central bank’s easy-money policy to tide over a crisis, whether stock prices have gone too high is a question that attends every market rally. With shares afloat on the ebb and flow of demand and supply, prices can go up and down in a wide range. It is for would-be buyers to judge what they think the apt price for any share is. For easy comparison, it helps to standardize the quoted figures. Since the basic point of buying a slice of a company is to get a sliver of what its business earns, a good way to size up a share on value-for-money is to look at what must be paid for every rupee earned by that share. This is captured by the share’s price-earnings (PE) ratio. If this ratio works out to 25, it means an investor is being asked for 25 per rupee earned by each share in the last fiscal year (i.e. if it’s a ‘trailing’ ratio). In a fast expanding economy, businesses usually aim to increase revenues and profits quickly. Listed firms that show steeper upward curves tend to have higher PE ratios, with buyers rushing in well ahead of profit upswells. Chances of distant jackpots to be hit also explain marvels like triple-digit PE ratios. Of course, frequent bets placed on yet-to-profit startups means infinite ratios don’t deter investors either. In India, as elsewhere, high risks for high returns account for much market participation.

While the pace of growth is a crucial part of any investor’s calculus, and it has a clear impact on equity price levels, there is another way to look at a PE ratio. It also represents an investment horizon. On paper, a PE ratio of 25 means it will take 25 years for the share to pay back the price paid for it if earnings stay constant. And if profits over the years happen to grow, full payback—with the share still held—would be that much closer. This perspective suggests that a longer investment horizon, an inalienable privilege of youth, could make high PE ratios look less expensive. Given India’s booming demat-account activity, a youth bulge could plausibly support higher valuations just by virtue of patience. But this doesn’t mean a market bubble is no risk.

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