India: Too much too soon

The Indian market deserves to be re-rated but a further premium to emerging markets seems unjustified at this point

After the recent rally since early March, the Indian market now trades at a price-earnings multiple (P/E) of around 16.5 times one year forward earnings. While that is no longer cheap, valuations today aren’t as much of a concern as they were even three months back simply because the outlook for the economy has improved, courtesy a more stable government at the centre.

Also, six core sector industries showed a growth of 4.3 per cent year-on-year in April compared with a low of 1.1 per cent in December 2008. The Indian market now trades way off its lows and at premium of around 50 per cent premium to emerging markets compared with its long-term average of 8 per cent---in January 2008 it was trading at a premium of over 100 per cent. As Morgan Stanley points out, broad market valuations as measured by market capitalisation to GDP, are now well past its historical average---the long term average is 49 per cent whereas at the end of May, the ratio stood at 87 per cent.

That makes the broad market look a lot richer than the narrow market. However, as market watchers have already pointed out, there is a good case for the Indian market to be re-rated; a stronger government can push through reforms faster, liquidity is now available and credit is becoming accessible on easier terms, a stronger stock market allows companies to mop up equity and thereby to de-leverage their balance sheets and most important demand seems to picking up so cash flows will ease. BNP Paribas’ earnings estimate for the Sensex, for 2009-10, has been upped from Rs 845 to Rs 868.

However, the market may be pricing in too much and even though the earnings outlook is now distinctly better, a higher premium at this point in time seems unjustified.

What could act as a bit of a dampener is the large supply of paper—about $2 billion dollars plus has been raised over the past month through equity issuances and companies say they’re looking to sell another $6 billion worth of stock. What’s really worrying is that about half of this is from property firms.