Nifty’s PE multiple is still attractive, corporate profits are looking up, and the country’s economy is relatively stable

After the Nifty’s 31 per cent gain in 2014, the Indian stock market is among the most expensive in the world, going by the price-earnings (PE) multiple of the index.

The Nifty’s PE multiple, at 15.8 times estimated earnings for the next one year, is way higher than that for any other BRIC nation, or South Korea, the UK and Germany. So why do market watchers still recommend Indian stocks?

Accelerating growth

There are three reasons. The first is that Indian markets are still not exorbitantly priced, if you take past valuations into account.

Trading at 15.8 times one-year forward earnings, the Nifty is still attractive when compared with its five-year historical average of about 16 times; and far lower than the lofty 22-24 levels of 2008.

The second is that you need to evaluate the PE ratio in relation to the denominator — corporate profits. Corporate profits in India have improved 15.5 per cent in the past one year and are expected to grow 22 per cent in the next, according to Bloomberg estimates.

More expensive markets such as the US (S&P 500) and Japan (Nikkei 225) are seen growing at a slower pace. While US earnings are expected to grow 8.3 per cent and Japanese earnings at 14.8 per cent, their indices also trade at 16-18 times their one-year forward earnings.

As for cheaper markets such as South Korea (Kospi), Brazil (Bovespa) or Russia, their corporate profits were in a free fall in the last one year.

What’s helping India is also that earnings growth is expected to accelerate further.

Nifty company earnings grew at a depressed 8-9 per cent between 2007-08 and 2013-14, picking up to 15.5 per cent only this fiscal. This gives rise to expectation that growth can ‘revert to mean’.

“You can’t look at the PE in isolation. It depends on where you are in the earnings cycle. At the peak of a strong earnings cycle even 15 is quite high. But at the beginning of a good earnings cycle even a 25 PE may not be very expensive,” Sukumar Rajah, CIO-Asian equity, Franklin Templeton Investments, told BusinessLine recently.

Nowhere to go

The third reason why Indian markets may be sought-after is that they offer relative stability in a wobbly global scenario.

Among the BRIC markets, Russia has been beaten down by the recent crude oil collapse and sanctions linked to the Ukraine crisis. The rouble has weakened sharply. Cut to Brazil, and as a big commodity exporter, it is also looking at a sharp slowdown and is vulnerable to the recent global commodity price rout.

Markets such as Indonesia are none too well placed due to political risk.

Among developed markets, the Euro Zone is still grappling with a dodgy recovery while Japan has been faltering.

China is the only other market that looks attractive on growth, but worries about its export-led model and shadow banking problems have triggered investor worries about its numbers.

Five ‘I’s

Foreign investors, thus, seem to be finding Indian markets attractive. Macquarie Research in its India strategy report bets on the five ‘I’ s that would drive India’s growth — infrastructure, interest rates, ‘India made’, indirect tax reforms and the internet.

The brokerage pegs its Nifty target (base case) at 9,940 for December 2015, and expects the index to go up to 17,400-21,500 over the next five years.

Credit Suisse in its Asia-Pacific report makes the case that “India’s PE premium to global equities may only come down after years of repeated policy mistakes.

“A few quarters of delay will most likely be ignored.”

Birla Sun Life AMC, in its 2015 equity market outlook, expects India’s GDP growth to scale up to 6.3 per cent in 2015-16, from 5.4 per cent in 2014-15, driven by consumption and improvement in investment demand.

The report suggests a 20 per cent annual growth in corporate profits over the next four years.

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