Modi at Helm, Valuations may Now Get the Fizz Back
Benchmark indices trading at 15 times their forward P/E, the fastest expansion in EM basket
Indian stocks may start commanding premium valuations again compared with its emerging market peers as the new government has revived expectations of a rebound in economic growth. Last year, this premium had shrunk as investors were shunning a larger section of domestic stocks because of slowing growth, elevated inflation and uncertainty about the country’s prospects.
In the last one year, India’s benchmark indices have seen fastest price to earnings (P/E) multiple expansion in the emerging market basket. Benchmark indices — Sensex and Nifty — are trading at 15 times their forward price to earnings, in comparison to 12.38 times in April 2013. Among its emerging peers, Taiwan’s TAIEX Index is trading around 13.49 times, against 12.92 times a year ago. Indonesia's Jakarta Composite Index is trading at 13.23 times, against 13.32 times a year before. “FII inflows and news flow post elections such as Cabinet formation, the Union Budget, etc. could drive price to earnings ratio further,” said Rahul Singh, head of equity research at Standard Chartered Securities. Till 2010, Indian indices traded at higher valuations. But, with consumption slowing, investors’ faith in domestic stocks waned last year. Indian markets have rallied over the last eight months and have led to PE expansion, despite earnings cuts by brokerages over the last few quarters. Market participants were betting on a favourable outcome of elections. “Markets are aware of weak earnings drivers in the near term, though optimistic about a future recovery in fundamentals,” said Neelkanth Mishra, India Equity Strategist, Credit Suisse, in a note to its clients. The MSCI India Index has rallied 13% over the last six months and has outperformed MSCI Emerging Market Index. FIIs have invested nearly .` 45,000 crore into equity markets so far. “We believe the prospects of positive policy momentum could keep valuations expensive while earnings play catch-up,” said Bhuvnesh Singh, MD & head of India research, Barclays. Corporate sector earnings are expected to grow at 16% CAGR over FY14-16. As earnings growth recovers to 20% over the next 3-4 years, valuations will also tend to trade above average of 15 times. “We believe that pro-growth policies and reforms undertaken by the government are likely to give further impetus to re-rating of valuations,” said Rajat Rajgarhia, MD, institutional equities, Motilal Oswal Securities. “The recent rally has taken market valuations to a zone where they can no longer be termed cheap,” said Bharat Iyer, MD & head of India research at JP Morgan.
A positive policy momentum could keep valuations expensive while corporate earnings play a catch-up game