India underperforms Asian rivals amid earnings and valuation strain

AI Summary

India's stock market is currently underperforming compared to its Asian peers, with significant losses attributed to pressures on profits and high valuations. Analysts suggest that reliance on the AI sector in other countries highlights India's weaknesses in profitability.

Mumbai: When the equity market of the fastest growing economy is inflicting losses on investors in contrast to those growing at half the rate but returning 50% in less than six months, there appears to be a paradox. But there could be reasons behind it, however outlandish they may sound.It is perplexing for some as to why Indian equities are down 7.5% this year while South Korea, whose economy is projected by the International Monetary Fund (IMF) to grow at half of India's - at 3.3% - has rallied 74% drawing global investors. The answer lies in corporate earnings and not economic growth.Every few years, a fever grips the investing community and that drives a set of stocks to dizzying heights even while others in the same market languish. The current theme is that of Artificial Intelligence (AI) . While most of the companies like OpenAI and Anthropic that are driving the transformation are still in private markets, the desire to grab a share of that pie is driving the average investor to listed companies securing revenues from those pioneering AI.Silicon chips are the foundation on which the AI revolution stands. Any company producing them is a winner. Nvidia Inc., a chip maker, is valued beyond $5 trillion, which is more than the GDP of India. This craze to own the future is spilling over to South Korea and Taiwan where a few companies such as Samsung Electronics are involved in producing the chips for AI.The rush to own chip makers has pushed South Korea's market value to $4 trillion, double that of its GDP. In contrast, India's market capitalization is at around $4.9 trillion while the GDP is around $4.15 trillion.What is making the difference? Samsung Electronics and SK Hynix, the chip makers!The revenue and profit potential of companies developing Large Language Model AIs may still be on paper, but the earnings for those supplying chips are real.The unprecedented demand for chips is forcing analysts to forecast earnings growth of 220% for Korea and 58% for Taiwan. By contrast, India that doesn't have a direct AI play is at 18%.Some analysts project Samsung to earn a profit of $250 billion this year and SK Hynix $150 billion. Taiwan's TSMC is projected at $100 billion. The entire Indian listed corporate system may earn around $200 billion. When Korean and Taiwan companies are growing, Indian companies are staring at a cut in their earnings estimates.Even if the earnings are skewed with just a handful of companies, investors chase value where those assets are still cheap compared to Indian companies. While Korea is trading at around 9.5 times, Taiwan is at 19 times forward year earnings. In contrast, India is still at 19.5 times which makes the local market unattractive even to other peers - reflected in MSCI EM at 12.5 times."Global markets are pricing in 20-40% EPS growth, 12-18 times price-to-earnings, versus India's 18% EPS growth,'' says a strategist at Motilal Oswal Securities. "A sustainable earnings growth delivery is critical for reversing the underperformance.''Apart from the relatively poor corporate earnings growth and steep valuations, India's long-term dependence on capital flows for meeting its imports is translating into a weaker financial market.The US-Iran war has not only pushed up energy prices by more than 40% steeply raising import bills, it is also threatening to disrupt supplies in the medium term if the war doesn't end soon.Indian rupee is trading at historic lows as foreign investors pull out record funds as they chase assets that are attractive in terms of valuations as well as earnings growth."The most exposed macro variable to the current shock is the balance of payment, followed by fiscal position,'' says Aastha Gudwani, economist at Barclays. "Administered prices mute immediate inflation pass-through, but at the cost of growing fiscal strain if supply risks persist. Balance of Payments is likely to reel under the stress of shrinking capital inflows.''This is a further blow to overseas investors who read their returns in US dollar terms. Looking through that prism, the Nifty is down about 8% since its January peak in Rupee terms, and 12% in USD.To be sure, warnings have been sounded on Wall Street's highly skewed AI investments.The key to reversing India's underperformance lies in boosting corporate earnings and easing macro pressures. Or, in the bursting of the AI bubble.