Market cap to GDP ratio

Market cap to GDP ratio signals upside for stocks

With the Modi led government third Union Budget around the corner, investors are once again pinning their hopes on big bang reforms to boost the economy.

But, in recent years, the stock market has not mirrored the economy well. The market cap to GDP ratio is currently well below 100 per cent, indicating that stocks have room to move higher.

This ratio measures the value of all the stocks listed on Indian exchanges against the GDP and is used by analysts to see if the stock market is rightly valued.

As a thumb rule, when the ratio moves well cheap jerseys above 100 per cent, stocks are said to be expensive and when it is far below 100 per cent, stocks are assumed to be cheap.

Based on the GDP growth estimate for 2016 17 (which was revised down recently), the current market cap to GDP stands at 74 per cent. While this is an improvement from the 64 per cent recorded in 2012 13, the current level is almost half of the 149 per cent recorded in the bull market frenzy of 2006 07.

Weak earningsOne of the reasons why stock prices are lagging the GDP value is the poor performance of listed companies. Revenue and earnings of companies in the CNX 500 index have been lacklustre over the past few years. While revenue for these companies has grown by 5.4 per cent annually between 2011 12 and 2015 16, net profit has been more or less flat (0.2 per cent) during this period.

There has been vast variance in the growth between sectors too. For instance, while revenue and profit for software companies have grown (annually) by a robust 16 and 18 per cent, respectively, capital goods companies sales and earnings have shrunk annually by 4.4 and 11.7 per cent, respectively, during this period.

InconsistencyBut, the lower ratio could also be due to difference in their constituents. For instance, companies within the agriculture sector contribute close to 2 per cent of the total market capitalisation of BSE listed companies. The contribution of agriculture to the GDP is much higher at 17 per cent.

Similarly, in the GDP estimates for 2015 16, banking, finance and business services contribute close to 20.6 per cent. But banking, financial and information technology companies account for close to 24 per cent of BSE market cap. Such variations make the comparison across market cap and GDP very difficult.

Aditi Nayar, Senior Economist, ICRA, says, correlation between GDP and market cap growth rates is not direct. Moreover, the growth in various indexes also reflects the possible political, geo political and sector specific risks. Besides, the unlisted companies are many. In some sectors, their component is very high. IPO marketAnother reason for a depressed Mcap/GDP ratio could be lacklustre IPO market. Market capitalisation can expand rapidly only if fund raising takes place actively. But, with the constriction in demand and companies postponing their capital expenditure, the primary market in the country has not been too robust of late.

The Indian IPO market also went through a lean phase since 2010 when SEBI clampdown on investment bankers and companies that indulged in malpractices led to the IPO market drying up completely for a few years. Between 2005 and 2010, the number of new initial public offerings was 345, nearly three times the offers made between 2011 and 2016.

Yet another influence on market cap is foreign fund flows. While foreign portfolio investors have mostly been pumping money into the Indian equity market, there have been periods when they have turned net sellers, due to global upheavals, influencing market capitalisation. Between 2011 12 and 2014 15, FPIs net purchased crore of stocks. But, in 2015 16, FPIs pulled out crore, leading to fall in stock prices.

(This article was published on January 29, 2017)

Following are the highlights of Union Budget 2017 18, presented by Finance Minister Arun Jaitley in Parliament today:

Tax rates halved to 5% for income of Rs 2.5 5 lakh, tax slabs unchanged

10% surcharge on people earning between Rs 50 lakh 1 cr

15% surcharge on annual income above Rs 1 cr to continue Cash transactions above Rs 3 lakh banned

Corporate tax for SMEs with turnover up to Rs 50 cr cut to 25%; 96% companies to benefit

Customs duty of LNG halved to 2.5%

Fiscal deficit pegged at 3.2% next year, 3% in FY’19

Political parties barred from accepting cash donation beyond Rs 2,000 per individual. They can receive donations via cheques, electronic mode; electoral bonds to be issued by RBI

Aadhaar based health cards for senior citizens; a scheme for them to ensure 8 per cent guaranteed returns.

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