India’s Growth Won’t Be Trumped
November 12, 2016
India liquidity crunch hurts precious metals
November 18, 2016

I know the India Growth Story, but what am I paying for it?

There is increasing recognition of India’s strong macroeconomic tailwinds of rising GDP growth, falling inflation and increasing foreign reserves, a thriving corporate culture, fuelled by entrepreneurial spirit as well as its pro-reform, pro-business Government, willing to take tough action to fight corruption and bureaucracy.

A Correction

These are all positives for investors in the India growth story from a long-term perspective. However, in the short term we have witnessed a fall of approximately 10% over the last two months, driven by:

  • Concern over a Trump victory in the US election and the impact this would have on emerging market domiciled company’s
  • Volatility surrounding the Fed’s potential for hiking interest rates. Currently the view held by 92% of economists is that a hike may occur in December 2016. A rising USD, quite often the fallout of interest rate hikes is generally not a friend to emerging market equity returns
  • The Prime Minister of India’s recent “demonetisation” strategy has left the economy starved of liquidity in the short term will have some impact on consumer and infrastructure type companies

Our view at India Avenue is that this is potentially a great entry point for a long-term investment in India’s equity market. We feel this is one of the best ways to play the growth story, given liquidity, strong equity market infrastructure and an ecosystem of close to 6,000 listed companies.

Focusing on Fundamentals

When we refocus on the fundamentals, then India’s corporate earnings growth of 13-14% per annum over the last 25 years is largely reflective of well managed businesses, driven by well credentialed entrepreneurs, who have thrived in an economic hotspot.

However, typically in an economy where companies are generating strong EPS growth, valuations tend to get stretched to reflect the longer-term potential that exists. Quite often this increases the volatility of the market as investors try to time the entry and exit points based on valuation. This is synonymous with behaviour of developed market investors, investing in stock markets of Emerging Market economies.

Currently India’s forecast earnings trajectory looks strong using consensus forecasts:

Table 1: EPS Forecasts, P/E
MSCI India = 961 EPS FY16 (a) EPS FY17 (f) EPS FY18 (f) EPS FY19 (f)
MSCI India EPS 46.09 53.76 65.44 78.74
Earnings Growth 3.2% 16.6% 21.7% 20.3%
P/E 20.9 17.9 14.7 12.2

Source: Bloomberg, MSCI, India has a fiscal year end of 31 March

The key assessment for investors to make is the validity of the earnings forecasts. Even if we slice 20% off earnings then we end up with a 15x multiple for close to 15% earnings growth from FY17-19.

Link Between Valuation and Returns

When we look back at forward valuations over time and relate that to the experience of investment returns made in the subsequent 3-year period, the relationship is extremely significant (R-squared of 0.91).

Chart 1,2: 3 year returns vs P/E 12-month forward





Source: Bloomberg, MSCI

Whilst this is no rocket science, it reiterates that valuation entry point does play a large role in success of the investment experience. Remember the number in the first chart above are average 3 year returns for each P/E band. Therefore, anything 16x and below has produced a strong entry point for investors to earn on average double digit returns over a 3-year period.

Current valuations reflect the long-term average for India of approximately 16.6x forward earnings. However, it’s interesting to note is that earnings have been held back over the last 2 years due to dilution of commodity company earnings (as small as this weight might be in the Index), lack of business investment given low capacity utilisation and weak monsoon conditions (till this year).  We expect earnings growth to accelerate in FY18 and FY19.

Chart 3: Current Valuation vs Historical Valuation



Source: Bloomberg, MSCI

Positive Outlook

In a low interest rate world, we may question whether these returns are achievable going forward. However, India appears poised for strong corporate earnings growth built on increasing business capital expenditure, infrastructure requirements of over US1 trillion, consumption through falling interest rates, rising wealth, low household debt and high savings. The Government’s action on reforms, initiatives as well as its crackdown on corruption abode well for increasing foreign investment as India’s status as an economic powerhouse increases.

Additionally, one of the best ways to mitigate valuation is through active management which can differentiate between stocks which appear cheap relative to their growth profile and stocks where forecast growth is already priced in. Over the first two and half months we have witnessed significant value add through our valuation focused adviser, given current market conditions.

It is our view that the recent correction of 10% in Indian equity markets forms a great entry point for investors who believe in India’s long-term growth story.