Key points
> Companies in SENSEX are back to the high earnings growth stage, a stage last seen between FY 2002-08
> There is a strong possibility that SENSEX will rise to their all time highs, and indeed, move beyond that
> We are bullish on Indian equity market and forecast that the SENSEX will cross 23,500 points by March 2013
> The foreign institutional investors (FIIs) are also bullish on India, due to high growth prospects of the economy and Indian companies
> There is a strong possibility that SENSEX will rise to their all time highs, and indeed, move beyond that
> We are bullish on Indian equity market and forecast that the SENSEX will cross 23,500 points by March 2013
> The foreign institutional investors (FIIs) are also bullish on India, due to high growth prospects of the economy and Indian companies
The Rising Market
For the past 6 financial years (FY2004-10), Indian equity market has been one of the best performing equity markets in the world. From the Chart 1, we can see that the benchmark index, BSE SENSEX has led the stock market rally and given compounded returns of 20.98% during these 6 financial years. This financial year alone (as at Oct. 12 2010), the equity market is up by 15.26%, with the SENSEX currently trading at 20203.3, just 669 points away from all-time high of 20,873 points which was earlier scaled on 8 January 2008. In fact, the bell weather index is on a roll for the past two months delivering 12.32% return. To put these returns into perspective, the year to date (YTD) return of SENSEX (as at Oct. 12 2010) has been 15.68%. In this article, we take a look into the future to see if the Indian equity market still has steam left to generate returns.
For the past 6 financial years (FY2004-10), Indian equity market has been one of the best performing equity markets in the world. From the Chart 1, we can see that the benchmark index, BSE SENSEX has led the stock market rally and given compounded returns of 20.98% during these 6 financial years. This financial year alone (as at Oct. 12 2010), the equity market is up by 15.26%, with the SENSEX currently trading at 20203.3, just 669 points away from all-time high of 20,873 points which was earlier scaled on 8 January 2008. In fact, the bell weather index is on a roll for the past two months delivering 12.32% return. To put these returns into perspective, the year to date (YTD) return of SENSEX (as at Oct. 12 2010) has been 15.68%. In this article, we take a look into the future to see if the Indian equity market still has steam left to generate returns.
Chart 1: Performance comparison of SENSEX with major global indices
Earnings Growth
The key determinant of share prices in the long run is Earnings per Share (EPS) of a company. Although the prices may deviate in the short run from their earnings trend, in the long-term however, the prices follow the earnings integer. In this context, the earnings of the companies in SENSEX had grown at a compounded rate of 17.08% during FY2002-08, which was followed by a bull-run wherein, the index moved from close to 3500 points to over 20,000 points as seen in Chart 2.
Earnings Growth
The key determinant of share prices in the long run is Earnings per Share (EPS) of a company. Although the prices may deviate in the short run from their earnings trend, in the long-term however, the prices follow the earnings integer. In this context, the earnings of the companies in SENSEX had grown at a compounded rate of 17.08% during FY2002-08, which was followed by a bull-run wherein, the index moved from close to 3500 points to over 20,000 points as seen in Chart 2.
Chart 2: Relationship between SENSEX and EPS of SENSEX 
Now, according to consensus estimate gathered from Bloomberg (Chart 3), companies in SENSEX are back to the high earnings growth stage, and are expected to touch all-time high in the next two financial years. Hence, based on the growth in the earnings, we have estimated SENSEX to cross 23,500 points by March 2013.
Now, according to consensus estimate gathered from Bloomberg (Chart 3), companies in SENSEX are back to the high earnings growth stage, and are expected to touch all-time high in the next two financial years. Hence, based on the growth in the earnings, we have estimated SENSEX to cross 23,500 points by March 2013.
Chart 3: Estimates of EPS of SENSEX for the next 3 Financial Years
Liquidity Driven Market
Liquidity Driven MarketWe can expect market to cross 23,500 levels earlier than March 2013, if Foreign Institutional Investors (FIIs) continue to be bullish on India. Even the FIIs are chasing the earnings growth of Indian companies and are continuing to invest huge sums of money into India. This is evident from the huge inflows into the Indian markets. As at 11 October 2010, the FIIs have pumped in USD21.7 billion, the highest inflows into India ever.
Apart from FII flows, India has been receiving a steady stream of investments in the form of Foreign Direct Investments (FDI). According to Department of Industrial Policy & Promotion, from April 2000 to June 2010, over USD 170 billion has been invested into India through the FDI route, in comparison to FII equity investment of USd 68.5 billion in the same period.
Indian economy and Indian Companies to grow fast
In the coming decade (FY2011-2020), we are sure that Indian economy will get into sustained high growth trajectory which can lead to higher growth in companies` earnings.
There are several reasons to be upbeat about India`s economic growth; the important ones are listed below.
In the coming decade (FY2011-2020), we are sure that Indian economy will get into sustained high growth trajectory which can lead to higher growth in companies` earnings.
There are several reasons to be upbeat about India`s economic growth; the important ones are listed below.
> Infrastructure Thrust: The 11th five year plan (2007-12) had estimated that over USD 1 trillion is expected to be invested in the infrastructure sector in 12th Five Year Plan (2012-2017). Most of these investments will be in public infrastructure space like power, ports, airports, roads, railways, etc. This will benefit not only Indian companies in terms of higher revenues and profit but also for global companies on account of technology transfer fees.
> Demographic Dividend: According to a US census department report, India`s dependency ratio (ratio of total dependant population to the total working age population) is expected to fall from 62.0 in 2000 to 49.6 in 2020. This means that India will have more people in the working age category than ever. The media has termed this fall in the dependency ratio as the demographic dividend. We are already seeing the effects of the demographic dividends in the rising GDP and increased domestic consumption. Increased domestic consumption implies higher revenues to Indian companies. We expect domestic consumption to accelerate more in the future.
> Robust domestic economy: Even though the Indian equity market is tightly coupled with the rest of the world, the Indian economy is relatively insulated from the negative economic events across the world. This relative immunity is due to the huge domestic consumption and is one reason why the economy was able to jump back to its high growth trajectory with a smaller stimulus by the government post the 2008 crisis as compared to the policy initiatives from the developed nations.
> Tax collections: At 6.8% of the GDP, the fiscal deficit is a major concern for the policy makers on account of three stimulus packages and tax cuts extended to industry during the period of financial slowdown. The government had set a fiscal deficit target of 5.5% of GDP for FY2010-11. We expect the fiscal deficit to be below 5.5% as a result of huge and unexpected auction inflows from the 3G and broadband spectrum and a 13.9% rise in the direct tax collections (between April and August 2010). Due to the higher-than-expected growth in the economy and tax collections, we expect the fiscal deficit to reduce at a much faster rate than the road map given in the Union Budget 2010.
> Implementation of GST tax regime: In a study conducted by National Council of Applied Economic Research, the implementation of GST in India is expected to increase the GDP by 0.9% to 1.7%. The present value of the GST-reform induced gains to the GDP is expected to range between USD325 billion and USD637 billion (discounted at a real rate of 3%.)
Macro risks for Indian economic growth
> Inflation: The high level of inflation in the economy is a worry for the banking regulator. Despite hiking key policy rates five times YTD, inflation is higher than the level expected by the Reserve Bank of India (RBI). The RBI is trying hard to control inflation without affecting the growth. We expect the inflation to moderate in the coming months.
> Current Account Deficit: The widening of Current Account Deficit (CAD) of India seems to be a concern for most economists. Currently, the CAD for June 2010 quarter widened to USD13.7 billion, from USD4.5 billion a year ago. Traditionally, the deficit had stayed well below USD10 billion, but for the past three quarters, it has exceeded the USD10 billion mark. Our exports have fallen due to lower demand from developed world but India`s economy grew at over two year high of 8.8% in the first quarter of FY2010-11 leading to higher imports.
> Execution Issues: Even though around USD 1 trillion is expected to be invested in the infrastructure, the execution of those infrastructure projects has always been an Achilles heel of India. According to the India Infrastructure Report 2009, the primary woe of any infrastructure developer is land acquisition. Much of the land for any infrastructure project needs to be acquired from farmers so, the government has been trying to draft a policy that involves job security and / or profit / revenue sharing with the farmers which can appease all parties involved in land acquisition process. Apart from land acquisition, corruption and bureaucratic hurdles are other problems.
Conclusion
India is one of the fastest growing economies in the world. Robust economic growth along with improved public infrastructure, demographic dividends and increased domestic consumption will lead to higher profitability for Indian companies. Hence, based on the consensus earnings estimates, we expect SENSEX to exceed 23,500 points by March 2013. Precisely so, the FIIs are bullish on India because of the same reasons.
Macro risks for Indian economic growth
> Inflation: The high level of inflation in the economy is a worry for the banking regulator. Despite hiking key policy rates five times YTD, inflation is higher than the level expected by the Reserve Bank of India (RBI). The RBI is trying hard to control inflation without affecting the growth. We expect the inflation to moderate in the coming months.
> Current Account Deficit: The widening of Current Account Deficit (CAD) of India seems to be a concern for most economists. Currently, the CAD for June 2010 quarter widened to USD13.7 billion, from USD4.5 billion a year ago. Traditionally, the deficit had stayed well below USD10 billion, but for the past three quarters, it has exceeded the USD10 billion mark. Our exports have fallen due to lower demand from developed world but India`s economy grew at over two year high of 8.8% in the first quarter of FY2010-11 leading to higher imports.
> Execution Issues: Even though around USD 1 trillion is expected to be invested in the infrastructure, the execution of those infrastructure projects has always been an Achilles heel of India. According to the India Infrastructure Report 2009, the primary woe of any infrastructure developer is land acquisition. Much of the land for any infrastructure project needs to be acquired from farmers so, the government has been trying to draft a policy that involves job security and / or profit / revenue sharing with the farmers which can appease all parties involved in land acquisition process. Apart from land acquisition, corruption and bureaucratic hurdles are other problems.
Conclusion
India is one of the fastest growing economies in the world. Robust economic growth along with improved public infrastructure, demographic dividends and increased domestic consumption will lead to higher profitability for Indian companies. Hence, based on the consensus earnings estimates, we expect SENSEX to exceed 23,500 points by March 2013. Precisely so, the FIIs are bullish on India because of the same reasons.
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