India Equity Market Valuations: The Need to Exercise Prudence

Abstract

While the earnings recovery has yet to realize itself, equity markets in India have continued to move up. As indices have moved up while earnings have largely failed to keep pace, valuations, to the extent that one bases them on the current earnings power of the business, have increasingly extended themselves in the overvalued zone. At Multi-Act EquiGlobe and at Sapphire Capital, we are primarily focused on a small sub-set of businesses. Our target investment universe is comprised of high quality businesses that possess durable competitive advantages. In our efforts to effectively answer the question of top-down valuations, we built a bottom-up model of companies in our investment universe; the India Moats Index. Our analysis covers 65 unique companies over the last 12 years. We take a deep dive into the profitability of these businesses as a group, levels of leverage employed, business reinvestments and share buybacks, and business valuations. Our findings suggest that the high-quality business sub-set is overvalued as well. We find that the valuation dispersion within the high quality business space is continuing to be wide allowing us to selectively construct a superior portfolio as compared to the wider investment universe.