If you are undecided about investing in equity markets, here is some help from HDFC Mutual Fund, India’s largest fund-house. HDFC Mutual Fund, whose equity investments are managed by Prashant Jain, has given a buy call on Indian equities based on a popular Warren Buffett yardstick. Called the market capitalisation-to-gross domestic product (GDP) ratio, stock market guru Buffett uses this to assess the valuations of US markets. When it comes to Indian equities, HDFC MF feels this ratio is quite attractive. Read on to know more.
The market cap-to-GDP ratio is widely used in the developed world. If the market cap hovers below the country’s GDP, people consider the market to be undervalued. With the Sensex at 36,500 levels and the Nifty 50 at 10,900 levels (as on February 1 closing), the usual talk about valuations gives an impression that Indian stocks are not cheap.
The link between big-picture economic indicators and specific companies and their stock prices may at times be fickle. Unless you are looking at futuristic numbers, GDP to market cap ratio is a backward-looking indicator comprising past data. Many also feel this indicator is useful only at extreme points e.g. in 2009 (markets went up by 81%) or in 2008 (markets crashed by over 50%).
In its equity market outlook, HDFC Mutual Fund has argued that India’s market cap to GDP on FY20 estimates is at ~61%. This is attractive, the country’s largest AMC reckons.
If you look at the numbers from 2005 onwards, the FY20E market cap to GDP indicator looks as cheap as in 2011, when it was at identical 61% level. In 2008, the indicator had fallen to 56%.
Certainly, Indian equity markets in 2019 do not look as expensive as in 2017 when market cap to GDP ratio was 93%. Since then, the ratio progressively became cheaper. At least, this is what the data indicates. For 2019, the estimate is 68%.
Market cap to GDP ratio
In Price/Earnings (P/E) terms, markets are trading near 16.7 times the FY20 (estimates) and 14.5 times the FY21(estimates) which are reasonable, especially given the low-interest rates. “In fact, as earnings growth improves, the P/E’s should look more reasonable and move lower,” HDFC Mutual Fund said in a budget note sent out to investors.
The fund house, which manages the largest mid-cap fund (HDFC Mid-Cap Opportunities) and second largest multi-cap fund (HDFC Equity Fund), has reasoned that in view of the expected jump in earnings, investors may boost equity allocation.
“In view of the above and expected recovery in earnings, there is merit in increasing allocation to equities, especially in multi-cap/large cap funds in a phased manner or in staying invested as the case may be (for those with a medium to long term view and in line with individual risk appetite),” HDFC Mutual Fund says.
Wholesome earnings growth has been a mirage for Indian markets. Do note that profit growth over the last few years was muted due to challenges faced in some large sectors such as corporate banks, metals, capital goods, etc. However outlook for these sectors is rapidly improving and these sectors should witness a sharp improvement in profitability, HDFC Mutual Fund opines.