Current capitalization of the Indian equity markets is about 64 per cent of the India's estimated GDP for the financial year 2013.
This is trading at near its 13 years average of 62 per cent and almost 40 per cent lower from its peak in 2008. This indicates relatively lower valuations of the Indian markets compared to its historical valuations.
Market cap to GDP ratio is frequently used by many of the investors to gauge the valuations of the markets and understand the possible direction of the markets. At the peak of markets in the year 2008, this ratio went up to almost 103 per cent. The market experts suggest that whenever the ratio crosses the one there is reasons to be caution. The Indian markets ultimately crashed post the 2008 peak and the ratio dropped to almost 55 per cent in the FY09. Since 2009 even though the Indian economic has grown and global uncertainties have eased out partially, the markets are still trading near long period averages.
In fact post the 2008-09 global economic crisis the earnings have improved but valuations are still low. For instance the Sensex earnings per share since the financial year 2008 has grown from Rs 833 per share to Rs 1,125 per share in the financial year 2012, a growth of 35 per cent in last four years. Despite this the valuations are near historical average. This is also a reason that the experts suggest there valuations are comfortable and despite a recent run up in the markets investors do not need to panic as the valuations are supporting. Valuations are not only comfortable on the basis of market cap to GDP but even the price to earnings ratio depicts the similar picture. If we look at the market cap to GDP ratio along with the price to earnings ratio, which is equally important ratio and widely used to gauge the valuations, the Indian equity markets are cheaper.
Based on the FY14 estimated earnings price to earnings ratio of Sensex at current levels of 18675 works out to about 13 times, which is good from the historical perspective. In fact on this matrix, the valuations are trading at discount to their long term average. On an average over the last 10 years Sensex has traded at about 14.8 times of its one year forward earnings.
This includes the peak of 2008, when Sensex touched the price to earnings ratio of 24.6 times its next year’s expected earnings. However that is not the case today as currently index is trading at almost half of its peak in 2008.