The Long Case for India

India has continued to produce unrelenting economic growth, but shares of Indian companies are mostly lower so far this year. The benchmark index on the Bombay Stock Exchange is the Sensex, which has fallen 5% so far in 2007. Despite the anticipated corporate earnings growth of 15-17% in 2007, shares trade at a cheap forward P/E ratio of just 15. Foreign direct investment from companies seeking to outsource, along with portfolio investments from investors should drive stock prices higher.

GDP growth remains strong at the 9% level, but inflation concerns recently forced the Reserve Bank of India to hike short term interest rates by half a percent to 7.75%. The increase was put in place to combat inflation, which is currently at a rate of about 6.5%. The considerably high interest rates have induced fears that growth will deteriorate, but the steps taken by the Reserve Bank should help India continue to experience sustainable economic growth without sacrificing too much purchasing power for the population.

Some experts are predicting 8% GDP growth into 2008 followed by some moderation. Although shares of major Indian companies have been ascending throughout the current phase of economic expansion, many companies remain undervalued and still have great potential into the future. Chinese stocks have advanced much faster than their Indian counterparts, leaving many bargains for astute investors.

ICICI Bank (IBN) is one of the largest banks operating in India with a 30% market share, and is well positioned to take advantage of high interest rates. Over the past twelve months, the stock has returned 50%, the highest among all Indian companies trading in the US. The company is expected to grow its earnings by about 24% annually for the next five years and should benefit from consolidation in the financial services industry.

Infosys (INFY), the big IT outsourcing firm has also performed well over the past year, gaining about 50% in value. The company recently reported strong earnings but forecast slower growth into the future as the US economy slows down. Infosys’s hefty valuation and slowing growth make it appear to be an overplayed stock.

A better option is Dr. Reddy’s Laboratories (RDY), a $2.5 billion drug manufacturing company. Dr. Reddy’s forward P/E ratio of 15 is cheaper than Merck’s (MRK) 19, and profits are more correlated to spending from the Indian population, without being affected by slowing US growth. Even when economic growth in India slows, pharmaceutical companies are in a defensive industry and will consistently produce earnings.

Internet portals Sify (SIFY) and Rediff (REDF) have struggled to become profitable and aren’t suitable investments unless they prove they can monetize their users and internet traffic better. Both companies would do well to copy the business models of Google (GOOG), Yahoo (YHOO), or Baidu.com (BIDU) in order to benefit from high profit-margin advertising.

With no standouts among the individual ADR’s, investors should look to diversified funds where better returns can be realized. In addition to the benefits of professional management overseeing your money, certain funds offer access to directly invest in the Indian market.

Alternative ways to play a part in the economic expansion include traditional mutual funds, closed-end funds, and ETF’s. The Matthews India Fund [MINDX] is a no-load, no transaction fee mutual fund with over $700 million of assets. The 2% expense ratio is reasonable for what it offers: investments in companies listed on Indian exchanges that are otherwise inaccessible to US investors. The fund is up 50% over the last 2 years, and best suited for retirement accounts.

The India Fund (IFN) and Morgan Stanley India Investment Fund (IIF) are closed-end funds and a good option for investing when sentiment is negative, allowing you to purchase the underlying securities at a discount to their true net asset value. These funds have no minimum investments and can be bought and sold just like stocks. Look to purchase these funds at bargains after a temporary correction.

New ETF offerings also provide a way to gain exposure to a diversified array of Indian stocks. Barclays offers the iPath MSCI India Index Fund (INP). The iPath invests in the 68 largest companies by market cap on the National Stock Exchange of India. The ETF has an expense ratio under 1% making it a very efficient method of investing in India. This investment is a great option for a regular account that you rebalance and analyze at least twice a year.

Indian stocks can be expected to surge over the near future. The tremendous growth of the country is remarkable and should continue to net large returns. Indian stocks have not had quite the outsized gains as China, and the lack of information flow can make for great opportunities. Investors will likely dump more money into the emerging markets and now may be a good opportunity to add a diversified Indian fund to your portfolio.

Disclosure: none

Comments

[Gaurav]

There are a lot of other companies - Tata Motors, HDFC Bank, WIpro etc. Besides a lot of call centres - WNS etc. are getting listed in the US. Any opinions on them?

[alesmith_]

Matthews India (MINDX):
1) Is up 5% this year while the Sensex is down the above-mentioned 5%.
2) Is a good example of active management sometimes being worth the premium.
3) Just lowered its expense ratio to 1.41% from the above-mentioned 2%.

Lookin' good.