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Prashant Jain, Founder, 3P feels that the higher valuation of equity markets or price to earnings (PE) multiple can be justified.
At the recent Cafemutual’s CafeAlt Conference 2024, Jain attributed this valuation to high growth of the Indian economy, low cost of capital and high liquidity through local flow of savings.
Jain said, “Our growth rates have moved from 5-6% to 7% and more. Secondly, the cost of capital in India has reduced drastically. As your cost of capital moves lower, naturally, PE multiples move up. Third, I think where you all (the distribution community) have contributed and done a commendable job is today the local flow of savings towards equities is so large that market volatility has gone structurally lower. Lower volatility will encourage households to even further increase their allocation towards equities.”
Currently, almost 10% of household gross savings go to equities. This can go up to 30% in future, Jain said.
Jain said that he feels that investors should invest in large cap funds and multi cap funds as they offer better risk reward. He recommends investors to avoid investing in mid cap and small cap companies and sectors like manufacturing and defence, which have seen good run up in recent times.
Talking about the corporate profitability, he said that corporate profits have recovered completely and should grow at 12-14% over the 3,5- and 10-year period.
While many believe that equities will continue to deliver stellar returns, Jain believes that it would not continue in future. The stellar returns were largely due to low base effect due to covid. While there has been adequate demand and flow of money in the markets, the supply of equities has also gone up substantially due to the IPO frenzy, said Jain.
Time to reset return expectation
Investors should reduce their return expectation from equity markets. Any business grows in two ways – real growth and inflation. The real growth of the economy is around 7% currently and inflation is 4%. Hence, the return expectation should be around 11-12%.
While the real growth did not change a bit over decades, inflation reduced significantly post 2000. India is now a lower inflation country.
However, real growth will increase to 7% and more going forward.
What will drive this growth?
Manufacturing is finally coming to India because of two reasons – low cost (low wage and per capita income) and better geopolitics conditions (Many companies want to diversify beyond China).
Another reason is that services export is going up. Post covid, remote working has gained acceptance and many global companies are setting up global capability centres (GCCs) that shifted a lot of jobs to India. As a result, the current account deficits have declined and attracted foreign direct investments.
Also, the gap between 10-year G-sec yield in India and US has reduced to 2-2.5% compared to 4-6% in the past. So, the cost of capital came down drastically. Finally, capex is reviving strongly in India.
