Weak earnings, lackluster IPO market and inconsistency make market cap lag GDP growth.
The market cap to GDP ratio is currently well below 100 percent, indicating that equity has 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 above 100 per cent, stocks are said to be expensive and when it is far below 100 percent, 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 percent recorded in 2012-13, the current level is almost half of the 149 percent recorded in the bull market frenzy of 2006-07.
The poor performance of listed companies has led to the diminishing market cap/GDP ratio. Revenue of companies in the CNX 500 index has been declining 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 percent) during this period.
There has been a vast difference in the sector-wise growth too. For example, while revenue and profit for software companies have grown (annually) by a vigorous 16 and 18 per cent, respectively, capital goods companies’ sales and earnings have declined annually by 4.4 and 11.7 percent, respectively, during this period.
Lackluster IPO market
Another reason for a poor Market cap/GDP ratio could be lackluster IPO market. Market capitalization can rise rapidly only when fundraising takes place actively. But, due to constriction in demand and companies postponing their capital expenditure, the primary market in the country has not been too strong.
The Indian IPO market also went through a lean phase since 2010. Between 2005 and 2010, the number of new initial public offerings was 345, nearly three times the offers made between 2011 and 2016.
Foreign Fund Flows also have an impact on Market Cap. 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 capitalization. Between 2011-12 and 2014-15, FPIs net purchased 3,74,813 crore of stocks. But, in 2015-16, FPIs pulled out 14,172 crores, leading to falling in stock prices.
The lower ratio could also be a result of a difference in their constituents. For instance, companies within the agriculture sector contribute close to 2 percent of the total market capitalization 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’s market cap. Such variations make the comparison across market cap and GDP very difficult.
Aditi Nayar, Senior Economist, ICRA, says, “The correlation between GDP and market cap growth rates is not direct. Moreover, the growth in various indexes also reflects the possible political, geopolitical and sector-specific risks. Besides, the unlisted companies are many. In some sectors, their component is very high.”