Are Indian stocks cheap?

The S&P BSE Sensex index of Indian stocks, measured in Indian rupees, has gone sideways for the past three years as the economy has kept growing. The MSCI India index, measured in US dollars, is down over a third over the same time. The Indian P/E ratio has been cut in half, and the currency has weakened sharply. So what is going on? Are Indian stocks (shares) now cheap?

India is an important country in the most important economic growth region of the world, Asia. The population of India is a little over 1.2 billion, not far behind China’s population of 1.35 billion. That means Indians make up 17% of all the men, women and children on this blue-green planet. Another 193 million live in neighbouring Pakistan, and 164 million in Bangladesh.

India covers a total of 3,287,263 square km
India is 3.29 million sq. km. (1.27 million sq. mi.); about one-third the size of the U.S

But India remains a poor country despite strong economic growth in recent years. Gross domestic product (GDP) per person was around $1,500 in 2012, using official currency exchange rates. That compares to $6,100 in China, the other Asian giant. By this measure, China’s economic output per person is four times higher than India’s.

I’m a value investor by nature, which means I hunt for bargains. By that I mean things that I can buy at a price that is much lower than my estimate of what something is actually worth, or its “fair value”.

Usually this means buying shares (stocks) when they have a low price-to-earnings (P/E) ratio, although sometimes there are reasons to avoid even those shares. The idea is that the P/E will rise to a higher level in the next two to five years, although sometimes it takes longer.

I’m also looking for the prospect of decent earnings growth, say 10% or more a year, and a reasonable dividend yield, above say 3%. The idea is to find a combination of these factors that is likely to result in 15% or more profit on average. Often it can be much more.

…hunting out low P/E ratios and decent dividend yields is usually a good starting point for any investor.

I was trained in financial valuation inside one of the world’s largest global investment banks. So of course I use more complex methods before committing my money, or making recommendations. But hunting out low P/E ratios and decent dividend yields is usually a good starting point for any investor.

Indian stocks are something I’d like to own more of one day, but have been avoiding in recent years. The reason has been simple. They have been the opposite of what I look for. P/Es have been sky high and dividend yields have been low.

According to the Financial Times, the Indian stock market had a P/E of 24 and a dividend yield of 0.9% three years ago today. That shouts “very expensive” to a value investor like me.

Two years ago the figures were 17 and 1.3%, which said “still expensive”. One year ago it was much the same, P/E 17 and dividend yield 1.5%. So I’ve been keeping on the sidelines.

Here’s a chart of the MSCI India index going back five years. I like using the MSCI indices because they are all calculated in US dollars. Like it or not the US dollar remains the world’s main currency for trade and investment. Using indices calculated in dollars ensures that we can compare “apples with apples” when looking at different countries.

The MSCI India index going back five years. Calculated in US dollars.
The MSCI India index going back five years. Calculated in US dollars.

You can clearly see that Indian stocks, measured in dollars, have been poor investments since fourth quarter 2010. They’re down about a third. That said, in the short term they have bounced off recent lows.

To further understand why it’s important to look at stock markets using a common currency, in this case dollars, take a look at this chart from Bloomberg of the S&P BSE Sensex index, which is measured in Indian rupees.

S&P Bombay Stock Exchange Sensex index is measured in Indian rupees.
S&P Bombay Stock Exchange Sensex index is measured in Indian rupees.

This tells a very different story. Measured in rupees the market has gone sideways since fourth quarter 2010. The two indices contain slightly different stocks or weightings to stocks. But both are concentrated in India’s biggest companies by market capitalisation.

The big difference is down to the currency used to measure the stock prices. Measured in rupees, prices have gone sideways. But in US dollars they have fallen.

This is because the rupee has been a weak currency in recent times. The following is a five year chart from, showing the percentage change in the Indian rupee against the US dollar.

Indian rupee against the US dollar is down 30.87%
Indian rupee against the US dollar is down 30.67%

The rupee is down 31% over five years and 35% since late 2010. Investors in Indian shares that measure their wealth in rupees have seen prices go sideways in the last three years, as growing earnings have offset falling P/E ratios.

…international investors that measure their wealth in US dollars have seen their Indian investments fall by a third…

But international investors that measure their wealth in US dollars have seen their Indian investments fall by a third, due to the additional factor of a weak Indian currency.

India’s big problem has been, and continues to be, large twin deficits. The fiscal deficit was 5% of GDP in 2012, meaning the government is spending considerably more than it receives in tax and other income. At the same time the country has a large current account deficit of 5% of GDP, mainly due to a trade deficit.

Put simply, each year the country imports much more than it exports, as the following chart from the The Hindu Business Line shows (figures in millions of US dollars).

India imports much more than it exports.
India imports much more than it exports.

Part of that can be put down to imports of oil. Also India imports large amounts of gold, as Indians as a group remain the biggest buyers of the yellow metal in the world (although China may take that slot soon). The Indian government has been trying to stem the flow with ever higher import taxes on the shiny yellow stuff. But aside from gold and oil, other imports have also been increasing in recent years.

Indian imports by category.
Indian imports by category.

To make the accounts balance, India relies on large inflows into the capital account. In other words the country is exposed to the whims of foreign investors. Unless the country can attract large inflows of capital into fixed investment in businesses or into financial assets (shares and bonds) it risks having a balance of payments crisis.

In the long run India needs to produce more at home and find new export markets. It needs to industrialise. India has a massive labour force of 487 million, but 53% of them continue to scrape a living in the agricultural sector. In China the figure is 35% and falling. In Brazil (Brasil), a country famous for its agricultural production, only 16% of the workforce are working in agriculture.

At the same time the government needs to find a way to live within its means. But cutting spending it always complex politically, being used as it is to buy votes (in any democracy, not just India’s). It takes a long time to battle the vested interests.

Are Indian stocks cheap?

So where are we today when it comes to Indian shares? Are Indian stocks cheap?

According to the Financial Times the P/E ratio of Indian stocks is 14 and the dividend yield is 1.8%. To cut a long story short, that’s now in my “something to watch more closely” category.

There’s no hard and fast rule for when country stock indices are cheap. It depends on a lot of factors like price inflation, interest rates, public debt levels, the balance of trade…the list goes on. But as a general rule of thumb, a P/E below 10 will usually be a great buying opportunity.

The Indian twin deficits continue. Indian stocks are not yet firmly in the cheap category, and the dividend yield is low. So I believe the risks continue to outweigh the benefits for investors. OfWealthers should wait for a better entry point into the Indian stock market.

In the meantime I continue to recommend Russia as the outstanding value opportunity in the world. For now at least, India will have to wait.

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.