Dalal Street Investments

Valuations Still Attractive for Longterm Investors – Morgan

December 10, 2009

The biggest debate is about India’s multiple and whether it deserves to trade at a P/E premium to emerging markets. What is the sustainable premium for Indian equities, if any, and whether the current market multiple makes the market vulnerable to relative underperformance ?

On the long-term relative multiple, Morgan’s opinion is Indian equities deserve to trade at a premium (of around 25-30% versus the historical average of 8%) driven by the factors listed below. [This explains their optimistic target in the past.]

India is likely to add around 10 million new workers to its workforce on an annual basis. As the workforce grows, so will the savings and hence the growth rate. This will be the key driver to profit growthIndia will need to grow at 7% or more (vs. 7.1% over the past decade). This means to us that the country
is underinvested and will guzzle capital in the coming years. The implication of this is that India will depend on global capital market cycles unless it shifts funding sources to FDI.

Public debt and fiscal deficit (read: politics) will drive long-term interest rates or the cost of capital (in the absence of large-scale capital flows). Another aspect of politics is the democratic system, which works in India’s favor with respect to property rights even as it works against the country in terms of driving capital accumulation and capital efficiency.

As domestic savings rise, a younger population will likely take more risk with its savings, causing higher flows into riskier asset classes like equity shares. The flow of savings into equities is supported by a strong capital market infrastructure. Evolution of this capital market infrastructure determines access to stock markets and influences the market’s multiple.

And the other way of looking at it by Morgan – Indian equities are fairly valued. Whilst returns in 2009 were driven by the rerating of absolute valuations, stock returns in 2010 will likely be driven be earnings growth. India’s absolute multiples are trading at around the historical average

finally, The broad market appears distinctly more attractive than the narrow market. For one, the multiples are low and, for another, earnings prospects look better. The broad market will outperform the narrow market in 2010 and witness a rise in relative multiples.

So if you are a LONG TERM Investor, keep BUYING the Dips, contrary to what Kotak says, wait for the opportunity. Tailor it depending on your holding capacity.


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