One of the most popular arguments for investing in Indian equities is the fall in PE multiple of benchmark indices relative to (i) its historical averages and (ii) global emerging markets. Motilal Oswal Financial Services, estimates that currently, Nifty is trading at ~18% discount to its long-term average price-to-earnings ratio and 12% discount to its long-term average price to book ratio. The MSCI India Index is trading at a 35% premium to the MSCI EM Index, materially below its historical average premium of 72%.
While the fact of de-rating of Indian equities in recent years is indisputable, the nature of this derating is a topic of debate, in my view. It needs to be examined whether this derating of valuation is cyclical and therefore offers a good opportunity to increase exposure to the Indian equities; or is it structural; in which case it would also be worth examining whether there is scope for further derating, and therefore investors may look for curtailing their exposure to the Indian equities in their standard asset allocation matrices.
This examination would involve finding answers, inter alia, to the following questions:
(a) What factors led to the Indian markets trading historically at a premium valuation compared to the global peers? Are these factors still prevalent and support the argument for a premium valuation for the Indian equities?
(b) Is the derating of Indian equities purely due to temporary reasons like geopolitical uncertainties, inflation, rising global bond yields, currency depreciation, lack of domestic investment opportunities in currently popular themes like artificial intelligence, semiconductors, etc.?
(c) Are there any reasons to believe that the current phase in the global economic, political, geopolitical and development cycle has weakened the argument for a long term “India Story” on a durable basis?
(d) Is the derating for the “India Story” per se; only for the benchmark indices as several mid and small cap stocks trade at elevated valuations; or listed equities, or all of these?
(e) Could this derating be merely a “mean reversion”?
…to continue tomorrow