What is Market Cap to GDP Ratio (Buffett Indicator) | Latest India Number?

India’s Latest Market Cap to GDP Ratio

Introduction

In the current Equity market outlook, India’s Market Cap to GDP ratio jumped 104, at 20-year high as on March 18, 2021. The ratio was at 56, the sharpest decline in March 2020.

In March 2020, the Indian stock market seemed to be closer to the bottom of current correction phase. After the steepest correction of almost 30% (YTD), India’s Market Cap to GDP ratio is at its lowest since FY2010, leading to unprecedented collapse in market valuations in bear markets.

Market Cap to GDP Ratio, also popularly known as the Buffett Indicator is used to assess the valuations of the stock markets of a country. Let us discuss what does this valuation metric tell, how to interpret the ratio, what are the limitations of The Buffett Indicator in the Context of Indian Market Valuation etc.

Market Cap to GDP Ratio | The Buffett Indicator

Meaning

• Buffett Indicator is a valuation metric which is used for assessing whether the country’s stock market is overvalued or undervalued, compared to its historical average.
• The ratio has become known as the Buffett Indicator in recent years, after the investor Warren Buffett popularized its use. Warren Buffett believes that Market Cap to GDP Ratio is one of the best measure of where valuations of the market stand at any given moment.
• As per Buffett’s comment, the ratio is a simple way of looking at the value of all the listed stocks on an aggregate level, and comparing that value to the country’s total output (which is its gross domestic product).  

Formula

• Market Cap to GDP Ratio = (Value of All Listed Stocks in a country / GDP of the country) * 100
• Thus, It is a measure of the total value of all publicly traded stock in a country, divided by the country’s Gross Domestic Product (GDP).

Interpretation

• If the Ratio is :
  1. 50% to 75%, the market is said to be modestly undervalued
  2. 75% to 90%, the market may be fair valued
  3. 90% to 115%, the market is said to be modestly overvalued
• In short, if the Buffett Indicator is too high, it means that the companies are not producing enough to be worth their valuations on the stock market. Therefore a downward price correction is inevitable.
• The Buffett indicator is like a Price-to-Sales ratio for the entire country.  It relates very closely to a price-to-sales ratio, which is a very high-level form of valuation.
• In valuation, the Price/Sales or EV/Sales ie.(Enterprise Value/Sales) metric is used as a measure of valuation.
• A Price/Sales ratio of greater than 1.0x (or 100%) is generally considered a sign of being overvalued. On the other hand, companies trading below 0.5x (or 50%) are considered to be undervalued.
• In order to properly assess a company’s valuation, other factors have to be taken into consideration, such as margins, growth etc.
• This is consistent with the interpretation of the Buffett Indicator, which makes sense, since it’s essentially the same ratio, for an entire country instead of for just one company.

India’s Market Cap to GDP Ratio

• From the below chart we can clearly see that, the Buffett Indicator of India has rarely exceeded 100%. This is because unlike developed economies like US, India’s economy is dominated by the unorganised sector, which is unlisted.
• However, the Buffett Indicator is helpful in Indian context too. Whenever it has moved too far from the long-term averages, it has signalled a likely correction in over-optimism or over-cautiousness among market participants.

India’s Market Cap to GDP Ratio – Year-on-Year Trend

• The ratio is a backward-looking indicator comprising historical data. The historical average of India’s Market Cap to GDP ratio over the last 20 years period is around 75.
• Thus, we can say that stock market outlook in March 2020 (where the ratio is 56) was closer to its bottom. Thus the Buffett indicator gives investors an early warning before bottoming of the markets.
• In current Equity market outlook as on March 18, 2021, India’s Market Cap to GDP ratio jumped 104, 20-year High from 56, the sharpest decline in March 2020 (Lowest since FY2009-10).
  • Indian Stock market has gone through a big corrections due to Heavy sell-off by FIIs amidst Coronavirus outbreak. India’s GDP recorded the sharpest contraction of 23.9% and 7.3% in Q1 FY21 & Q2 FY21 respectively, resulting in lower TTM GDP base.
  • However, the Indian Stock Market are currently soaring to Life-time Highs on the back of the exceptional optimism in the markets over big boost from Budget 2021, Indian Inc reported bumper Profits Dec quarter (9-quarter High), Strong comeback of FIIs since Oct-20 and positive developments on COVID-19 vaccination drive.
• Thus, if we compare with the historical average market cap to GDP ratio of 75. Thus, we can say that current market outlook (where, Market cap to GDP ratio is at 104) is noticeably overvalued as compared with historical average.

India’s Market Cap to GDP Ratio – Monthly Trend

How the markets valuation changed month-on-month for FY2019-20? Below chart shows the monthly movement of India’s Market Cap to GDP Ratio.

• The historical average of India’s Market Cap to GDP ratio is around 74. Corporate Tax Rate Cuts (20th Sept-19) was a great boosting measure given by the Government to Indian Corporates to build business confidence and Removal of Surcharge on FPIs.
• FPI investments were started reviving after corporate tax rate cut announcements on 20^th Sept from earlier 30% to 22%. A positive sentiment has been built in the market due to expected increase in profitability of Indian corporates. Also, Roll-back of Super-Rich tax to revive economic growth and Government’s PSU Divestment drive, FPIs have been buying in Indian equity segment.
• As a result, there was a consistent rise in the India’s Market Cap to GDP ratio from 69 in September 2019 up to 80 in January 2020 (As shown in the above chart).
• However, after the Coronavirus outbreak in China, Italy, South Korea, United States, the overall sentiments of Foreign Investors got affected adversely due a number of uncertainties across global economic outlook. Heavy sell-off by FIIs in Indian Equity market was seen since last few weeks (February-20 & March-20).
• In Equity market outlook as on March-2020, India’s Market Cap to GDP ratio had corrected sharply at around 56. It is mainly due to the recent corrections in the stock market amidst Coronavirus outbreak and its impact on economic outlook, both domestic as well as global.

Equity Market Outlook as on March 18, 2021

• In current Equity market outlook as on March 18, 2021, India’s Market Cap to GDP ratio jumped 104 from 56 in March 2020.
  • So, from the above monthly trend graph, we can say that current equity valuations are considerably well above the historical average of 74. Thus, we can say that currently the market is trading at euphoric valuations, on strong optimism for future growth outlook.
  • The Indian Stock Market are currently soaring to Life-time Highs on the back of the exceptional optimism in the markets over big boost from Budget 2021, Indian Inc reported bumper Profits Dec quarter (9-quarter High), Strong comeback of FIIs since last 5 months and positive developments on COVID-19 vaccination drive
  • After bottoming out from 25,981 on March 23, 2020, BSE Sensex has soared by almost 102% reaching all-time high 52,516 on Feb 16, 2021, but market declined by 6.3% from this on profit booking, rising in US G-Sec yield.
• Strong Recovery of Markets is evident from the current all-time high index levels. From Dalal Street to Wall Street, Bull run continues on the bourses. All major Global Indices are trading at Life-time high levels currently.

• Strong FIIs Pumping into Indian Equities
  • FIIs has supported the Indian Stock Market to set for a recovery. A big boost by Union Budget 2021, Bumper Dec-20 quarter earnings and better-than-expected economic recovery supported to sustain FII momentum and optimism in the market.
  • Both Indices – Sensex & Nifty are trading at Life-time Highs on February 16, 2021. Though market has gone through a little correction in March-2021, with the rising US G-Sec Yield. As a results of which FII started pulling funds from Emerging markets like India.
  • As on 18th March 2021, Indian Stock Market soars record high up 30% from Sept-end. Mainly due to strong FII pumping into Indian Equities. FIIs were the net Buyer since October-2020 with the net inflow of Rs.1.87 Lakh Cr.

Limitations of The Buffett Indicator

• The market only encompasses the value of all the listed companies in the country. But the GDP is the value of all incomes which includes unlisted private companies, small businesses, MSMEs, proprietorship, partnerships, government companies, government departments etc. To that extent the numerator and the denominator are not entirely comparable.
• The ratio is impacted by :
  1. Trends in Initial Public Offerings (IPOs) and
  2. Percentage of companies that are publicly traded (compared to those that are private).  All else being equal, if there was a large increase in the percentage of companies that are public vs private the Buffett Indicator would go up, even though nothing has changed from a valuation perspective.
• The applicability of the buffett indicator is higher when the market cap reflects a much larger share of economic activity in the country. That is why the ratio is widely used in the advanced/developed countries like the US, UK, Singapore, Germany, Sweden where more of business comes under the formal sector.