Indian stock market may now be priced to perfection

Indian equities have surged 18% in dollar terms so far in 2017, the most among the world’s 10 biggest markets. With market value at $1.91 trillion, the highest since January 2008, the return reflects 10% expansion in price-earnings (P/E) multiple as well as rupee appreciation. But, the sustainability of these factors appears sketchy, hence, the debate whether Indian equities are ‘priced to perfection’ — whether valuations fully reflect positive triggers. 

The Indian market trades at 16.9 times FY18 projected earnings, a 20% premium to long-term average and one positive standard deviation away from mean. The farther it is away from mean, the higher the probability of it returning to the mean, statistically known as mean revert. Except for technology and healthcare stocks, most Nifty constituents are valued much higher than their long-term average. 

The most critical factor for premium valuation, earnings growth, has not been encouraging. Barring commodity stocks, most Nifty’s constituents have seen earnings downgrades. Also, the consensus estimate has overestimated earnings growth for the fifth year in a row. A report by Credit Suisse said India is the third worst among larger emerging markets, behind Mexico and South Africa, in over-promising and under-delivering on earnings growth in the past 15 years. 

India’s valuation premium against other emerging markets is also widening, touching 40.8% in April against 12-year average of 30%. On sector-adjusted basis, MSCI India trades at 19 times 12-month earnings, a 58% premium to the emerging market aggregate. It means a sharp rise has made market expensive in absolute and relative terms. 

On the currency front, the rupee is one of the strongest since the start of the year due to high positive real interest rates. Foreign portfolio investors invested $9.1 billion in Indian equities and debt in March.