It is very interesting to watch the various theories people come out to justify equity valuations. We are really ingenious in coming out with creative concepts to understand crazy valuations to mentally calm ourselves and make sense of the madness..
We started with Par values and then slowly moved on to the concept of premiums, wherein we were willing to pay something higher today considering the possibility that the stock price might soon catch up. Then some analyst came and taught us the concept of P/E ratios when we graduated from the world of additions (premiums) to the world of multiples (P/Es). When it became difficult for us to justify the stock prices even according to this concept of PE, we then went one more step ahead.
We broke down PE into trailing PEs and Forward PEs and calmed ourselves saying that a forward PE after all makes more sense. However, at today's Sensex levels even the forward PE is not in a position to justify valuations. But I read an article today which seems to have an answer. The article makes a convincing argument for coming out with a new measure - Market Cap to GDP.
The crux of the article is - Market cap of a company represents a public consensus on the value of a company and GDP is the sum of value added at every stage of production of all final goods and services produced in a country by both listed and unlisted entities. Market cap and GDP of a country together form a positive relation to determine the growth potential of the economy. The article thus concludes that India's Market Cap to GDP is as of now just 0.99 as compared to other countries like Singapore (2.65), UK (1.6), US (1.35) and China (1.10). It thus represents that India is significantly undervalued even at present levels.
There is a theory in marketing which states that once consumers have purchased a certain good/ service, they then look for reasons to justify their purchase behaviour. To me these things appear to exactly satisfy this concept. I dont know what measures will these guys come up in future to still justify that we are undervalued. Let me make their life simpler by suggesting a few things...
1. Earning Potential Vs. Market Cap - India's working population and their potential PPP adjusted average wages scaled up to developed economies compared with the market capitalization
2. Population to market cap - Assuming that the per capita market cap in US is XXXX, in India it should be atleast 3.5XXXX because we beat them black and blue as far as population is concerned.
3. Employees to Market cap - A US company produces so much revenues with X amount of employees. In India, we produce the same amount with 3X employees. So our market cap should be atleast 3x times that of US.
Dont laugh at these. The gravity defying Sensex might actually make all these ratios come true pretty soon.
