India Strategy Reports (updated)
The Art of Alpha Conclusion: While the MSCI Index EPS are up 23%annually since April 2003, it is the near doubling of thetrailing P/E that has been a bigger driver of the indexreturn of 262% over the past three years. Speculationabout a lower equity risk premium caused by the fall inthe price of risk, a secular decline in long-term interestrates and belief that India’s future ROE will be higherthan before has been at the helm of the 95% increasein India’s trailing P/E multiple to 23 times. What's New: India has outperformed emergingmarkets by 46% since April 2003, but, contrary topopular belief, this has not been driven by changes infundamentals. The fact is that India’s EPS growth hastrailed EM by 22% on a cumulative basis over the pastthree years. It has been a 67% expansion in India’srelative P/E multiple to 1.48 times that has caused thisstellar performance. With India’s ROE and dividendpayout spread with EM largely unchanged, theconclusion is that the re-rating is a function of a changein expectation of India’s relative future ROE and suchhope is not supported by trailing data. Implications: We see three risks to India’s P/Emultiple. First, the lagged correlation between interestrates and P/E is pointing to a decline in P/E. Second,as capital spending normalizes, ROE will likely undergomean reversion, lending support to our belief thatsustainable ROE may not be 20%+, as is implied bythe market today. As and when ROE expectationssoften, so will long-term payout prospects. Indiancompanies will have to retain more earnings to meetearnings growth expectations, with negativeimplications for P/E multiples. The immediate risk isthat the earnings cycle may have peaked. Last, riskappetite cycle could turn down, which would cause thecost of equity to rise – i.e. a rise in volatility of futurecash flows, with bearish repercussions on the market’sP/E multiple. Separately, we are replacing Grasim with ACC in our model portfolio to reflect our cementanalyst’s preferred stock in the sector. Click here for India Strategy report by Morgan Stanley Additional Readings:
- Click here for India Strategy report by Citigroup Smith Barney
- Click here for India Strategy report by Sharekhan
- Click here for India Strategy report by Merill Lynch
