Dalal Street Investments

Valuation of Indian Equities on Different Metrics

May 4, 2010

Indian Stock Market have over the last 10 years (and over 1995-2010 too) had a fairly robust correlation with MSCI- India real ROE. India Inc’s ROE (Morgan Capital Index-India) in FY11 will be 16.7%; lower than its 18-year average, meager when adjusted for Cost of Equity (ROE-COE: 3%).

India’s ROE swings have been driven primarily by changes in asset turn: profit margins, leverage, tax rates, and the cost of debt/leverage have had little influence on ROE. This should remain unchanged; rising asset turn, after a trough in 2010 (given current capex/capital raising plans), and higher operating margins, should drive up ROE in FY12 to 19%+. Bottom line, sales growth is key to higher ROEs; and there are signs suggesting that this is beginning to happen (4Q10 sales growth expectation at 17%).

India’s 18 year average ROE is over 17%, having peaked at 23% in 2007, and is estimated to dip below its long-term average in FY11. The following Chart shows the Historical ROE since 1991.

Regionally, even at below average levels Indian ROE’s are high. India’s peaks have been higher than peer peaks. India is expensive in PBV terms, at the higher end on nominal ROE, and at the lower end of real ROE.


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