The market-capitalisation (m-cap) of BSE-listed firms has topped the $3 trillion mark, making India the world's eighth-largest stock market after the US, China, Hong Kong, Japan, UK, France and Canada.
Among all significant developments in the market's journey to the $3 trillion mark, the m-cap to GDP ratio has seen a significant jump to 97 percent since FY04, which is higher than the average of 77 percent for the period but lower than the peak of 149 percent of GDP in 2007, according to a report by Motilal Oswal Financial Services.
The Buffet indicator is an important indicator that shows whether the market valuation is in sync with the economic reality or not.
The Warren Buffett indicator, as per Motilal Oswal, has come down from 105 in FY21 to 97 in FY22.
Is this a sign of caution?
Experts point out that the Buffett indicator is widely followed and works well in most economies, but India has its unique characteristics.
"India’s GDP does not capture a lot of activities that are either informal in nature (including the contribution by housewives) or are out of formal channel due to unaccounted nature of transactions. Estimate of the proportion of this number varies," said Dhiraj Relli, MD & CEO, HDFC securities.
"If one includes this portion, then the denominator will rise. Also in India, a lot of PSUs and private companies (including startups) are not listed and hence the numerator is also depressed."
Relli added that the impact on denominator is estimated to be much higher than that of the numerator. Hence, the actual indicator number may still be lower than the long-term average.
"We in India may have to closely watch (other financial ratios) P/E (price-to-earnings, PEG (PE/growth ratio), PBV (price-to-book value) ratios on an absolute and relative basis considering the unique advantages India offers to investors," he said.
Nitin Sharma, Director Research & India Site Head, Fidelity International underscored that one should be careful in interpreting this indicator in current times where the GDP has been hit owing to the pandemic, but the markets are more focused on an eventual recovery and are looking beyond the current year.
Sharma also believes that the Buffett indicator is less useful for an economy like India with a substantial proportion of GDP being from unorganised and the SME segment and is outside of the listed space.
"The decline in the indicator based on FY22 numbers is due to the widespread expectation of a return in economic activity to pre-pandemic levels by next year, which is leading to higher forecasted GDP," Sharma said.
A more useful approach, in Sharma's view, is to watch the earnings cycle for businesses and comparing it to the historical trend. On this front, a global recovery will support revenue and profit growth across regions and sectors.
"The key metric to watch will be inflation, where any increase beyond the comfort zone of central banks will lead to a reversal of the current easy money policies," he said.
Jyotivardhan Jaipuria, Founder and CEO of Valentis Advisors, pointed out if we look at the Buffet indicator or any other valuation parameter, it is clear that valuations are above the long-term averages.
"But we have to remember that they are always expensive at the low end of an economic cycle. We believe the valuation re-rating is behind us and returns will be driven by a doubling of earnings over the next 4-5 years," Jaipuria said.
Experts do not give much importance to the m-cap and GDP ratio in the Indian context.
"M-cap-to-GDP has been a poor indicator of market performance. The better thing to look at is the money supply to GDP. In the context of rising money supply and declining velocity of money, financial asset prices tend to bloat. Hence, the key thing is dollar supply, policy rates, and inflation outlook," said Dhananjay Sinha, Managing Director & Chief – Strategist, JM Financial Institutional Securities.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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