Sunday, April 20, 2014

Sensex Possibilities: a guest post

WIth Sensex touching new highs on a regular basis, analysts of all shapes and sizes have started to predict fantastic index levels without really explaining how and why those levels can be reached.

Despite the past few years of slowing GDP growth – a worldwide phenomenon – India continues to show positive growth. Things can only improve from here onwards – more so if a decisive government comes to power.

In a guest post, Niteen takes a look at likely Sensex levels now and in the future, based on the Market Cap to GDP ratio. History shows that Sensex doesn’t rise continuously to higher levels without occasional sharp down turns. However, the analysis provides a long-term view of possibilities.


As the market started taking cues from the election outcome possibilities, market players started predicting various Sensex levels. Some are predicting 40,000 and others talking about 60,000. But they all are unanimous that the Sensex is going to reach new highs.

Let’s have a rational approach and try to understand the Sensex level possibilities keeping in mind GDP and Market Cap. This is the classic ratio used by Warren Buffett over a period of time to understand the valuation of the market.

India’s GDP is US$2.16 Trillion which was $1 Trillion in Nov 2007. This is a phenomenal growth because many would not have expected us to touch $2 trillion so early. GDP size-wise we are amongst the top 10 nations in the world. If we had continued to grow at 9% per annum then we would have become a $5 Trillion economy by 2024.

We all know that the growth rate came down from above 9% levels to now below 5% and reasons are known, discussed and debated widely. Having said that, we could still achieve an average growth of 7% which is a very conservative number considering the aspirations of people of India. If we could continue to achieve just an average growth rate of 7% YoY then the $5 Trillion economy number will come by 2027 instead of 2024.

In fair market scenario, GDP to Market Cap ratio is 1 or 0.9. Presently, the Sensex is at 22600 levels with Market Cap of US$1.38 Trillion and GDP is $2.16 Trillion. The current ratio of total Market Cap to GDP is 0.64. The historical high was 1.65; the historical low was 0.41 and fair market value will be around 0.9.

I have taken three scenarios: best case (GDP to Market Cap ratio of 1.5), worst case (GDP to Market Cap ratio 0.4) and base case (GDP to Market Cap ratio 0.9) and drawn the Sensex levels keeping in mind the average GDP growth rate of 7% starting from 4.5% of this year in the below table. I have provided the projected Sensex levels under all the three scenarios.

Sensex levels


Best Case

Worst case

Base case

























































If the economy reaches $5 Trillion then the Sensex number should cross 50,000 while maintaining the same Market Cap to GDP ratio of 0.64. If the ratio goes up from 0.64 to 0.9 or 1.0 the market could cross 80,000. Looks ambitious but still very much possible…

The scenario presented above is especially important to highlight the importance of long term investment v/s short term gains. In short term, we have several hiccoughs which come in our way. So just basing our decision on the election outcome may not be a good idea. During last few years the market had been hammered with lot of negativity. It is not that many of them were not true. It is also true that the scenario will not remain the same. Good old days of 9% GDP growth is not there today but the next government, whosoever comes to power (Modi/Congress/Third front), will have to start initiatives to take the economy out of its slumber. Most analysts are predicting numbers based on best case scenario. However, a likely possibility is of base case scenario over a longer period.

I look forward to receiving your views.

P.S.: I have taken an average 7% GDP growth. The government is expecting a GDP growth rate of around 4.5-5%. I have taken a GDP growth rate of 4.5% for the current year and gradually increased it while keeping the average of 7% for the duration. We might have some period when the economy may grow faster than average and vice-a-versa.


(Niteen is an MBA and cleared CFA Level 2, CFA Institute USA. He also conducts investor education sessions, writes blogs. A firm believer in long-term financial planning, and a 20 years veteran of the stock market, he likes to analyse the economy, and individual stocks.

Niteen blogs at Investment ideas.)


Naveen Fernandes said...

Logical and well written. A query - a great deal of the Indian GDP is from unlisted entities. Would it be possible to get this ratio and compare it to the US data? The case may be different

Rajesh Javalagi said...

Indeed a very good discussion on co-relating the GDP with Market Cap.

Taking a conservative view, if GDP is suppose to grow at 4.5% (instead of 7%) you may want to revisit the calculations and see how it pans out...

Niteen S Dharmawat said...

Thank you for your comments. I have taken a number of 4.5% to start with and gradually moved it and then again brought it down (a range of 4.5-9%) for the period from 2014-2027 while maintaining an average growth rate of 7.5%. We can do the similar exercise for 4.5% average growth rate, however, I do not feel a need for that. Because it means we are talking about dismal average growth rate of 4.5% with a range of about 2-6%. It will be better to not to invest in India in such a scenario unless we do not have any other options globally.

TheRamanforum said...

i am an investor myself and do my own research.for the index to reach those levels in the most optimistic scenario there must be a very healthy primary market too else one will only see very high PE which cannot be sustained.when more good companies get listed the overall market cap is bound to improve.however,that is not the case in the recent years.the bse 500 could be a better barometer as it has more stocks than the sensex.

Niteen S Dharmawat said...

Thank you for your comments. I agree that a great deal of India's GDP comes from unlisted companies. But ultimately it flows back to the economy and affects the larger organizations, spending by the government etc. If the economy is moving in either direction the mcap should move along with it. If mcap is not following GDP then we have extreme situations building in to exploit. Will still try to find if we can make it directly compare with USA.

Naveen Fernandes said...

Thank you for the healthy discussion. Allows for thinking and moving ahead without being dogmatic.
On Rajeshjis comment, I think 7.5% GDP growth is a very low rate to take. The GDP growth is always a REAL figure, so 4.5% growth (which is very low) is actually 10.5% if inflation is 6%).
The sensex is always a nominal number as it is not adjusted for inflation.

Shantilal Hajeri said...

Sensex is a senseless index. It can not be linked to any one factor. No body can explain why it took more than six years to jump from 21000 to 22000. any prediction of sensex is a mere speculation.

Maries R said...

Very good article. I need some clarification on the ratio you used. It was said that gdp to market cap varies from 0.4 to 1.5. This is calculated only on Indian markets or on global markets

Niteen S Dharmawat said...


There is so much of possibilities to improve and considering that 7% is a very conservative number. Look at agriculture sector. Our 60%+ population is dependent on it and what is the growth rate there, hardly 3-4%. Can't we improve? We can do much better here. My father comes from this industry so I know little bit about the possibilities. I had great hopes when MMS came to the power during his 2nd term. In fact, I wrote on my blog that we may now see 2nd wave of economic reforms. The first one started in 1990's improved our manufacturing sector and the second one would affect agriculture. This alone could have taken us beyond 9% growth on a consistent basis.

We may achieve, and rather deserve, much more than 4.5%. The last 5 years are lost. But it will still be helpful as the next government, whosoever comes to the power, will not dare to play with the economy.

In current scenario, PE is not that critical considering the fact that PE reflects the earning components against valuations. If earnings go up the PE will change drastically. However, if the GDP does not grow then where will market cap go, what is the downside? So from that perspective this ratio is important.

The new entrant in the sensex is a constant phenomena. It will continue to evolve. Once it was dominated by old industries, then FMCG, then IT companies... who will be now? Let's see which industries evolve over next 5 years? Remember, change is the only permanent thing. The things won't remain the same.

Niteen S Dharmawat said...


The market cap of all the stocks has come down when the GDP growth was coming down. So in a way it was reflecting the ground reality about the stagnant economy. Further, if the Sensex did not move it is an extrapolation of the same situation and was getting right with the economic fundamentals. It is good that Sensex did not move. Had it moved, it would have created a bubble to burst. In the current situation where the market cap and Sensex both moved up with lots of hopes, without any growth of the GDP. It reflects the hopes part. If these hopes are crashed because of whatever reasons then we are in a bubble for sure.

Niteen S Dharmawat said...

Mariesji R,
Thanks for your reply. This ratio is applicable to global market but the numbers provided are specifically of Indian market.

Nitin Goyal said...

You have all the increase in market cap in the Sensex only, whereas, we had seen that the increase in market capitalization of mid-size companies increases much more.

One just can't simply extrapolate the data. It would reflect a distorted figure, because, sensex is running very high, but, not the mid size companies index. Further, as rightly pointed out by Naveen, in India many companies are unlisted. Even many well known Govt companies are unlisted. Therefore, it is not that they don't have market capitalization.

Better way could have been price-earning of Sensex companies with an average assumption of their growth earning in 7% growth period.

Niteen S Dharmawat said...

Nitin Goyalji,

Thank you for your comments. I am with you and Naveenji on the points that you have mentioned. It is only one factor that we have taken into account and that is ratio of market cap and GDP growth. The outcome measured is the Sensex levels.

The problem with unlisted companies is that you do not have reliable data available in India about such companies. Also I will go a step further and say that what about black money economy. There are many guesstimates about this parallel economy which does not get accounted for. But again the issue is the reliability and availability of the data. In such a scenario it is better to use the best available options.

When you are saying that we should take into account only PE ratio then I may not agree. PE is another distorted ratio and may not convey much if taken into account on a standalone basis. It should be used in combination with dividend yield, price to book value and of course the market cap to GDP ratio. This may help. May be a good topic for my next write up.

CLEARWaTeR said...

Thank You Niteen for this insight