India's equity-market valuation premium over China narrows to 54.2%

Equity market trend attributed to faster growth in India Inc earnings

The premium of India’s equity-market valuation over its Chinese equivalent is now shrinking as stock prices correct on Dalal Street while they rally in Shanghai.

India’s premium over China fell to 54.2 per cent from 82.3 per cent at the end of August and a record high of 124 per cent at the end of September 2021.

For comparison, the Sensex valuation premium over China was, on average, 48 per cent in the past 15 years.

The trailing price-earnings (PE) multiple of China’s equity benchmark, Shanghai Composite Index, is up 17 per cent in September, while there has been a moderation in Sensex valuation in the last one month in line with a decline in stock prices at Dalal Street.

The Shanghai Composite Index closed at a trailing P/E of 16.1 times at the end of September, up from 13.7 times at the end of August. It is up 17.4 per cent during September and closed at 3,336.5 at the end of the month compared to 2,842.1 at the end of August.

The Chinese equity market is closed for annual holidays during the first week of October.

In comparison, the Sensex-trailing P/E multiple declined to 24.8 times on Friday from a high of 25.6 times at the end of September and 25 times at the end of August.The Sensex is down 3 per cent in October so far, closing at 81,688.5 on Friday, compared to an all-time high monthly close of 84,299.8 at the end of September.  Analysts attribute the “contra” rally in China to its highly discounted valuation. 

“Equity markets have a tendency to revert to the mean and capital is now rotating to China as valuations have become too steep. Higher valuation lowers the potential upside and raises downside risk,” said Dhananjay Sinha, co-head, research and equity strategy, Systematix Institutional Equity.

Others credit the rally to a turnaround in market sentiment after the Chinese government and the country’s central bank announced a new stimulus package.

“The new economic measures have raised expectations of faster earning growth in China but the rally could fizzle out if growth fails to materialise,” said G Chokkalingam, founder and chief executive officer, Equinomics Research.

Equity valuation in India overtook that in China for the first time in May 2010 and the Sensex has since maintained the valuation lead over China except for a brief period during April-June 2015.

India’s equity valuation premium over China’s reached a record high in the post-pandemic rally on Dalal Street.

It peaked in September 2021, when Sensex-trailing P/E reached an all-time high of 33.5 times compared to Shanghai Composite Index-trailing P/E of 15 times in that period (see the adjoining charts).

India’s valuation premium over China is attributed to faster growth in its corporate earnings. This was especially true in the post-pandemic period, when there was a sharp increase in Sensex-underlying trailing earnings per share (EPS) in both the local currency and dollars. In comparison, the Shanghai Composite Index saw a decline in its underlying EPS in recent years.

Sensex-trailing 12-month EPS is up nearly 61 per cent in dollars and 80 per cent in rupees since October 2021. In the same period, Shanghai Composite Index-trailing EPS declined by 20.6 per cent in dollars and 13.6 per cent in local currency.

The rupee and the Chinese renminbi have depreciated against the dollar in the past three years.

The Chinese currency is down 8.2 per cent against the dollar in the past three years while the rupee has depreciated 10.8 per cent against the greenback in the period.

In the last 10 years, Sensex EPS in dollars increased at a compound annual growth rate (CAGR) of 5.9 per cent compared to a 1.2 per cent CAGR decline in the Shanghai Composite index EPS (in dollars) during the period. Sensex-trailing EPS rose from $22.1 at the end of October 2014 to $39.1 on Friday.

In the same period, Shanghai Composite Index-trailing EPS declined from $33.5 in October 2014 to $29.5 now.

Growth in corporate earnings in India has been even better in the local currency. Sensex EPS has grown at a CAGR of 9.3 per cent in the last 10 compared to near stagnation in Shanghai Composite Index-underlying EPS during the period.

Poor earnings growth in China has been attributed to a meltdown and a string of bankruptcy in the country’s real estate sector, which has hit growth and earnings in many related sectors such as construction, building materials, metals and mining, mortgage lending besides real estate.

The latest rally in the Chinese equity market is attributed to sweeping stimulus measures announced by Beijing last week. The Chinese government unveiled a new plan that seeks a “significant interest rate cut”, the “countercyclical adjustment of fiscal and monetary policies”, and an end to “the decline of the property market”. This has lifted sentiment on Chinese equity.

In contrast, India saw a big jump in corporate earnings in the post-pandemic period led by sectors such as banking and finance, mining and metals, information technology, the automotive sector, and oil and gas.

Most of these sectors are now showing signs of earnings slowdown, which could weigh on corporate earnings in India going forward. This would narrow the performance gap between the Indian and the Chinese government in future.