India Most Expensive Among Emerging Markets, High Valuations Valid: HSBC

India is expensive for valid reasons— high return on equity, higher long-term growth potential and domestic appetite for equities, noted HSBC in its latest India Strategy note released on Tuesday.

The brokerage believes that the perceived risk for India is lower due to strong and proactive regulatory framework and institutions. Near-term slow growth and long-term deterioration in ROEs are downside risks, as per HSBC.

India is most expensive among the emerging markets - currently it's trading at price-to-earnings ratio of 20 times, it said, adding that compared to other countries like China, Indonesia, Korea, etc., it is 60% more expensive.

The brokerage noted that, most of the reasons to justify India's high valuations may remain intact in the near term. "Still, we believe long-term risks around growth and falling ROE need to be acknowledged," it added.

In India, household penetration of bulk of discretionary products is low. This means with growing per-capita income, most of the categories could continue to see sustained growth for many years. This includes automobiles, healthcare, insurance, consumer durables etc. High long-term growth in DCF models translate to high PE multiple, the brokerage added.

Average India ROE is higher than those of other major countries. This is true across sectors like automobiles, consumer staples, insurance, hospitals and even banks.

"For sectors like automobiles, the reinvestment rate and working capital requirements are much lower in India. Banks average ROA is around 1.2% in India vs 0.7% in China. For consumer companies, ROE is significantly higher due to pricing power and distribution strength," HSBC noted.

The brokerage further shared, that some of these moats may deteriorate. For instance, reinvestment rate for autos is increasing and distribution moat of FMCG is challenged now with quick commerce.

HSBC highlighted, "We have seen event that China-a shares command higher valuations than H shares due to higher domestic ownership. Impact of domestic investors becomes stark considering the low free float of Indian stocks. Average free float in India is still only 44% compared to 67% for peers."

Valuations factor in earnings potential of an asset's cost of equality. Of multiple factors, COE is dependent on the sovereign rating of a country. "For India, we believe the perceived risk is lower due to multiple reasons. India has rarely been impacted by a sharp macro crisis, unlike many other large economies," it added.