Most eyes see high PE of NIFTY and find Indian stock markets expensive. Although, the fact is that NIFTY has not even risen as much as the Indian economy in the last 10 years. The key fact to understand is that 2/3rd of NIFTY is composed of pertains to:

– Power sector

– Construction sector

– Metals

– Real estate

– Telecom and

– Oil & gas.

All these are balance sheet heavy sectors, and have under-performed in last 1 year.

So, Nifty is not right representation of stock market. In fact. auto, FMCG, Pharma, IT, Banks and Financial sector are the sectors that represent the Indian economy. Also the strength lies in its demographics and large young population base. Hence, a right portfolio mix decides the performance.

Over the past decade, Nifty’s earnings have not only grown at a much slower pace than the Indian economy but have also trailed the S&P500’s earnings growth by a country mile (although the Indian economy is growing much faster than the American economy). This disturbing phenomenon has far reaching implications for Indian investors.

The Nifty has fallen far behind the Indian economy.

Over the last ten years, India’s GDP growth (in nominal terms) has averaged 13% per annum. While the most popular benchmark index in India- Nifty- has seen its earnings grow at a mere 8% per annum.

In fact, in nine out of the last ten years, Nifty’s earning growth has trailed nominal GDP by a country mile (the only exception being FY11). In America, on the other hand, nominal GDP growth over the past decade has been barely 4% and yet the S&P 500’s earnings has grown at 12% per annum. A full 400bps faster than the Nifty (even without converting the Nifty’s earnings to US dollars)!

Why do the benchmark indices in India and America display completely opposite trends? (when compared to the GDP growth of their respective economies) Also what implications does that have for investors?

Why does the Nifty lag the Indian economy?

To understand why the Nifty no longer captures the dynamism of the Indian economy a good place to start is the index as it stood ten years ago. On the face of it, the ten year share price return from investing in the Nifty is a very respectable 14% but that is a flattering figure.

A better way to understand the quality (or lack thereof) of the Nifty is to look at the return from investing. The underlying fifty stocks which were in the Nifty ten years ago — such a portfolio (equal weighted) would give you a return of negative 1% per annum (CAGR over ten years).

Note: By starting the measurement in February 2009, when the market was close to its post-Lehman lows, we are giving the Nifty every chance to enjoy an unusually low base.

If you assume that the cost of equity of a typical investor investing in Indian stocks is 15%, only 18 out of the 50 stocks in the Nifty have given a return above the cost of equity over the past ten years. This number is also flattered by the fact that our starting period in Feb 2019. These 18 out-performers — ranked in descending order of performance — are:

  • HCL Tech
  • TCS
  • HDFC Bank
  • Maruti Suzuki
  • M&M
  • Zee
  • HUL
  • HDFC
  • Wipro
  • Tata Motors
  • BPCL
  • Infosys
  • ITC
  • Siemens
  • Hindalco
  • ICICI Bank
  • Grasim
  • L&T and
  • Sun Pharma.
    Apart from 4 companies, all the other companies are from relatively capital light. Or from B2C sectors like Consumer, Auto, Pharma, and Banking.

The other 32 companies — whose ten-year return is below the cost of capital — are from balance sheet heavy sectors. These include Power, Construction, Metals, Telecom, Real Estate, and Oil & Gas. These sectors accounted for roughly 30–35% of the Indian economy. Yet these companies account for two-thirds of the companies in the Nifty. It leaves a little room in the index for the more vibrant sectors of the economy.

The over-representation of Nifty in capital heavy sectors of the economy is a key reason for its sluggish performance. It is not obvious to us why the Nifty continues to have such a high proportion of companies from balance sheet heavy sectors.

Implications for investors

The sluggishness of the Nifty makes it relatively easy for reasonably competent fund managers to outperform the index. and unjustifiably claim the presence of skill. While this does pose a challenge for Nifty tracker/index funds (since they are tracking a moribund index), it also opens up enormous opportunities in India for smart beta funds.

We at PMS-AIF do unparalleled research, unbiased advise and suitable analysis.

Disclaimer: Investments are subject to market risk. This write up is issued by PMS-AIF and is produced for information purposes only. Information and opinion contained in this document are published only for the assistance of the recipient. It is neither a solicitation to sell nor shall it form the basis. Or be relied upon in connection with any contract or commitment whatsoever or be taken as investment advice.