Too Late To Buy India?

by: Shiv Kapoor

The Journey so Far

Let's wander down memory lane. It is New Year's Eve 1991, and it's been a year of sobriety for India. She has frittered away her meager foreign exchange reserves and been forced to approach the IMF, begging bowl in hand. And there, she is forced into the embrace of an open market economy. She accepts the embrace, first reluctantly and then with great enthusiasm. The Sensex closed 1991 at 1,909.

With the first baby steps towards an open market economy, 1992 was a year of hope. On New Year's Eve 1992 the Sensex stood tall, up near 37% at 2,615. Twenty-one years since the 1991 crisis, as India approached adulthood as an open market economy, on New Year's Eve 2012, the Sensex stood at 19,427 having delivered an annualized return of 11.5%. The growing up remains incomplete as India remains a tightly regulated economy, but progress we have seen and progress we shall see. We wait impatiently on the first giant strides of early adulthood.

During the near ten years since 31 December 2003 the Sensex has delivered encouraging annualized returns of 13.65%. But since 31 December 2007, the near six years ended 31 October 2013 has delivered a disappointing annualized return of 0.42% and it was not so long ago that the six-year annualized return was negative.

Between the end of 1992 and now, the average annualized six, ten and twenty year returns have been 11.15%, 12.75% and 10.07% respectively. History does not repeat itself, but it often rhymes. Thus over the coming ten years, the long-term return potential can be estimated at an annualized return of 12.75%. And from this long-term return potential expectation, using average plus or minus one standard deviation, over the coming ten years we can look for upside to an annualized return of 18.3% and downside to an annualized return of 7.2%.

A long-term return potential of 12.75% is attractive, even very attractive. But with the Rs being a currency in perpetual decay, a $ investor might not be so thrilled. Nonetheless, with an expected long-term currency depreciation rate based on inflation differentials adjusted for factor productivity differentials of about 2% to 3%, the net return potential remains attractive.

What Lies Ahead?

Sometimes it pays to throw out a seeming ridiculous thought such as Sensex 50K. And then figure how the efflux of time and value might make it plausible.

Sensex 50K

Fiscal year 2013 ended March 31, 2013 (FY13) closed with Sensex earnings per share at 1,190. For FY14 expectations are widely disbursed between 1,240 and 1,300. FY15 expectations vary between 1,450 and 1,520.

Over the past twenty years between 31st December 1992 and 31st December 2012, earnings per share grew at a 13.1% annualized rate, while growth over six and ten years has been 9.8% and 16.2% respectively. Cyclically adjusted earnings (the six year median earnings per share), over the past decade have grown at near 12.8% and this is a great indicator of forward long-term earnings growth potential.

With half of FY14 behind us, I suspect 1,250, which indicates 5% earnings growth is a fairly reasonable expectation. For FY15, earnings growth expectations, assuming expectations for 1,250 in FY14 are met are at between 16% and 22%. Such growth rates are optimistic but not impossible coming off two years where earnings growth has been well below long-term averages. A more conservative estimate for FY15 of 1,350 indicating earnings growth of 8%, which is in line with recent earnings growth, might be more appropriate. Such an estimate would have upside to 1,410 assuming we have full reversion to a 12.8% cyclically adjusted earnings growth rate.

Any government elected in 2014, other than a weak fractious coalition, will want a return of the virtuous cycle of growth. FY16, FY17, FY18 and possibly even FY19 could be very strong years. For those of a cynical disposition, with elections behind us, these years would not require populist budgets. And growth would be essential, because it is that growth which pays for populist budgets which will be required as the next election approaches!

In such a scenario, assuming earnings growth of 16.1%, which is in line with decade average growth rates, earnings per share by FY19 could approach 2,600. Look back to end 2003 when earnings were at 329. Fast forward to end 2007 when earnings were 804. That period delivered annualized earnings growth rates of 25%. A recurrence of such growth rates could take earnings to 3,400 by FY19.

Sensex at 50K by end FY19 would indicate a multiple of 19.3X with earnings at 2,600 and 14.7X with earnings at 3,400. Multiples of 14.7X to 19.3X earnings vary from cheap to expensive, and history tells us both are well within ranges seen in the past.

If the Sensex were to hit 50K by March 31st, 2019, persons investing today would earn a return of about 18% annualized which is on the high side of possible outcomes. It is however, what a person should fear losing out on.

Fear losses by all means, but balance it with fear of losing out on potential gains.

Come 2019 will it be Sensex 50K or will it be India's Decade of Despair?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. I am long several stocks in the India large and mid-cap space and this article contains extracts from my recent book Sensex 50k, or India's Decade of Despair which is available at the Kindle Store.