The India premium

India has historically traded at premium multiples compared to other emerging markets (EMs). On price-to-earnings (P/E) multiple, currently, it is trading at about 83 per cent premium based on consensus estimates. India certainly has been, and is projected to be, amongst the fastest-growing EMs (20-year real GDP growth of 6.5 per cent). However, GDP growth or even earnings growth, in and of itself, does not warrant a premium multiple or deliver higher returns. For instance, China has grown faster (20-year real GDP growth of 8.2 per cent) for a long time and yet has consistently traded at a discount. Further, its equity market has underperformed that of India over long periods measured in decades. This is similar to what is observed for relative multiples of individual company valuations. As we all know, the company with the fastest-growing sales or profits in any sector or country does not necessarily merit the highest multiple. In fact, other factors, such as corporate governance and the quality of underlying assets, usually are the dominating factors that impact multiples. It should not be surprising if the same is true for the overall market multiple across countries. In this column, we discuss why India has deservedly traded at a premium because of superior country-level governance and underlying asset mix. Governance factor To state the obvious, the value of any country's equity market is the sum of the value of its constituent companies, which in turn is the present value of their future cash flows. By investing in a company's equity shares, an investor effectively buys the proportionate rights to its equity cash flows into perpetuity. Where corporate governance is poor, there is a significant risk that cash flows would be diverted by controlling shareholders to the detriment of minority shareholders. As a result, the assumption of minority shareholders having a proportionate right to such a company's cashflows is weakened. It is not surprising, then, that such companies trade at discounted multiples compared to their better-governed peers. The weaker the governance, the greater the discount. By logical extension, shareholder rights to the perpetual cash flows of equities would be more valuable in jurisdictions where such contractual property rights are less prone to being challenged by other parties, including the authorities, and where, if challenged, an institutional framework exists