 "Do Indian equities deserve to trade at a premium?")
Equity markets continue to be skittish after Ben Bernanke indicated the days of easy money could be over. Over two years, equities have been driven largely by foreign money and after the steady fall over the last couple of weeks, valuations have dropped below the 10-year average. So, are valuations now attractive or fair, given the problems faced by the economy? After 2003, whenever valuations have dipped below 13.5x, strategists have rushed to term these attractive. Until 2003, Indian equities traded at a discount of nearly 10 per cent to other emerging market peers. This changed as steady corporate earnings profile resulted in a re-rating. Over the last decade, Indian equities have commanded a premium of 37 per cent over other emerging markets. Corporate India's earnings have compounded at an annual rate of 15 per cent since 2002. In contrast, earnings compounded at an annual rate of two per cent between 1995 and 2002.
Given the risks the Indian economy faces, of high deficits, currency risks and slowing economic growth, should Indian equities continue to command a premium? Morgan Stanley's Ridham Desai believes long-term investors needn't worry if the market is trading below its fair value. The markets offer adequate risk premium to investors willing to look beyond the current situation, he thinks. There is a reason behind this thinking. Not only have corporate India's earnings grown rapidly after 2002 but the volatility in earnings has also been low. After the Lehman crisis broke in 2008, global earnings fell 48 per cent but India Inc's earnings fell a mere three per cent, says Morgan Stanley.
A big reason behind the low volatility is also the diversified composition of the index. No one sector dominates enough to swing it in good or bad times and this brings stability to earnings. According to Standard Chartered Securities, 30 per cent of the indices comprise stocks with high "visibility" and the price to book and return on equity of these safe stocks have expanded since 2010. This has helped not only lift valuations but also sustain these at elevated levels. Standard Chartered's Rahul Singh believes the 10-year average price/earnings multiple of 14.5x thus, needs to be adjusted for the rising premium in the "low-risk" index constituents.
Not surprising then that Indian companies feature prominently in Morgan Stanley's regional listing of companies with the best business models. Of the 31 companies compiled by MS, eight are Indian. If one excludes expensive sectors like technology, consumer and financials, the premium commanded by Indian equities actually shrinks to 19 per cent from 35 per cent. In the current scenario, views like these may find few takers, but it adds another nuance to Indian equities and their valuations.
Given the risks the Indian economy faces, of high deficits, currency risks and slowing economic growth, should Indian equities continue to command a premium? Morgan Stanley's Ridham Desai believes long-term investors needn't worry if the market is trading below its fair value. The markets offer adequate risk premium to investors willing to look beyond the current situation, he thinks. There is a reason behind this thinking. Not only have corporate India's earnings grown rapidly after 2002 but the volatility in earnings has also been low. After the Lehman crisis broke in 2008, global earnings fell 48 per cent but India Inc's earnings fell a mere three per cent, says Morgan Stanley.
A big reason behind the low volatility is also the diversified composition of the index. No one sector dominates enough to swing it in good or bad times and this brings stability to earnings. According to Standard Chartered Securities, 30 per cent of the indices comprise stocks with high "visibility" and the price to book and return on equity of these safe stocks have expanded since 2010. This has helped not only lift valuations but also sustain these at elevated levels. Standard Chartered's Rahul Singh believes the 10-year average price/earnings multiple of 14.5x thus, needs to be adjusted for the rising premium in the "low-risk" index constituents.
Not surprising then that Indian companies feature prominently in Morgan Stanley's regional listing of companies with the best business models. Of the 31 companies compiled by MS, eight are Indian. If one excludes expensive sectors like technology, consumer and financials, the premium commanded by Indian equities actually shrinks to 19 per cent from 35 per cent. In the current scenario, views like these may find few takers, but it adds another nuance to Indian equities and their valuations.