Why are Indian Equities So Overvalued?

On the heels of India’s tax hikes on equity trading, aimed to hamper $2 trillion added to Indian market caps in just four years — the fastest ever — it is worth investigating why India’s stocks keep rallying so much. India’s indices are now worth over $5.5T,  the 4th largest in the world, a point of pride and concern for policymakers.

Overall, Indian equities trade at a forward P/E ratio 80% higher than other EM equities, and 10% higher than U.S. equities, making them among the most expensive stocks in the world. Some specific industrial and consumer companies especially standout: Adani Enterprise boasts a staggering P/E ratio of 109.68, Tata Consumer Products has a P/E ratio 102.27, and Nestle India’s is 83.84 (as of COM July 23); these are more than triple and quadruple the multiples U.S. tech companies typically trade at.

Why?

(BTW: P/E ratio is the ratio of a company’s stock price to its earnings-per-share and is a common valuation method. Forward P/E ratio is the ratio of a company’s stock price to its projected 12-month earnings-per-share and is seen as more relevant metric since markets will price companies based on projected growth or decline.)

Fundamentals are good, but not great:

  • Return on equity and realized growth rates have been skyrocketing with the last 5 years averaging 14%.

  • India, even in a high rate volatile environment, is projected for 6.8+% growth this year. This has boosted small and mid cap stocks considering the growing housing market and digital infrastructure boom. 

  • Multinational companies like Hyundai and Cadbury are listing with high capital raises drawing in more speculation and demand.

  • However, the valuations of many companies grow despite falling revenue. 300 Indian companies had declining revenue for two consecutive financial years, yet 216 of their stock prices rose in the last 12 months, as per CNBC.

Retail Investors are bullish: 

  • Kotak Institutional Equities has called Indian stocks highly overvalued and argues it is driven by the “extreme euphoria” of retail investors

    • Retail investors have been forking up more of their money into stocks, with 2% of households investing in 2011 to 17% in 2023.

  • Systematic Investment Plans (SIPs) have also become drivers of high valuations. In recent years, SIPs, which are programs that automatically take cash from an individual’s account and invest it into mutual funds, have become hugely popular.

    • This causes a steady inflow into mutual funds that are limited by their mandates on how much cash they can hold — as a result, major funds are forced to pour money into stocks with less attractive valuations

    • “[SIPs] have driven the upsurge in the Indian stock markets,” Jefferies’ head of India research, Mahesh Nandurkar, told CNBC.

    • In just May 2024, 5 million new SIPs were registered

Systematic limitations force more money into Indian equities:

  • Retail investors are limited by the supply of shares. 

    • 45.1% of India’s p publicly traded companies have more than 50,000 individual shareholders, a figure that’s doubled in the last 10 years

    • 55 companies have more than 1 million individual shareholders; 10 years ago, just seven did

  • Mutual funds have a $7 bn industry aggregate cap on investing in overseas equities, meaning that the ballooning of inflows into mutual funds in recent years has nowhere to go but to get piled into Indian equities. Indian mutual funds have a collective AUM of $738 billion.

    • RBI has not raised this cap in two years

  • Similarly, individuals in India are capped at investing $250,000 in overseas equities per year. While this affects only a small number of highly wealthy Indians, it forces hundreds of billions of dollars of wealth further into Indian equities

RBI institutes these caps to limit Indian money from leaving the country, which protects the stability of the currency. However, rather than the Modi government hiking taxes to bring gravity to stock valuations, which only erodes the wealth of investors and forces them to buy higher volatility stocks to cover higher costs, they should make it easier for individuals and mutual funds to buy foreign equities so that Indian stock valuations have to be justified against cheaper stocks abroad. Similarly, as readers of Samosa Capital are astutely aware, Indian regulators don’t make it easy for foreigners to buy shares trading on the NSE or BSE, further insulating Indian stocks from reality. Liberalizing financial markets will let some air out of Indian stocks while poising their companies for healthy long-term growth.