In a bullish note to clients, the Indian equity research arm of Morgan Stanley has cited good fundamentals and low volatility as key for India’s impressive performance. But it cites past performance as an indicator to the future, without the context in which such past performance was achieved, namely low starting valuation and low interest rates

Morgan Stanley Research Asia-Pacific (Morgan Stanley), in its latest report titled “Secret Touch” is bullish and expects Indian markets to perform well, vis-à-vis her peers, on account of “superior macro growth story” and “diversified index in terms of sector concentration”. According to this view, which has come well after the market has rallied strongly against the consensus view of poor macro-economic fundamentals of India, the bottoms-up story is strong and is expected to keep earnings stable. Stability in earnings means reliability in forecasts. It said, “One of the underpinnings of this fundamental story (India’s story) is the relative stability in earnings and high earnings growth over the long term.” India has given an annual Earnings Per Share (EPS) growth return of 14% since 2001, with standard deviation of just 13%, the lowest amongst peers. While this may be impressive, averages are always deceptive. Besides, in the four of those years, the market valuation was low and interest rate were falling, which is the sweet spot for equities.
 

Read more of our stock market analysis here.
 

Morgan Stanley argues that India is fairly diversified, vis-à-vis NSE Nifty, when compared to its peers, and makes the market more stable. In Taiwan and Turkey some sectors occupy more than 50% of the weightage.
 

Read our analysis of Morgan Stanley report on ‘TINA’ for a brief background, especially on the aspects of sector weights and diversification.
 

One of the interesting observations in this report is that the “beat ratio” (the ratio at which companies beat expectations) of NSE Nifty companies is 63%, which is higher than the MSCI average of 50%. In other words, for every three companies in the Nifty, roughly two beat estimates. The report said, “These statistics just underscore the role of corporate fundamentals in the solid performance of Indian equities over the past decade.” One would be led to thinking that Indian companies are performing well. However, there’s a flip side to this approach; estimates sometimes are generously set low so that estimates can be beaten. “Despite historical low earnings volatility, consensus expectations are usually beaten,” the report said. Very often brokerages do this in order to induce clients to buy shares. For instance, in Morgan Stanley’s report, Axis Bank, Coal India and GAIL—all achieved “100% Beat Ratio” between 2005 and 2012. It is pertinent to note that Axis Bank hasn’t performed that well relative to its peer—HDFC Bank (88% beat ratio)—even though Axis Bank may have ‘beat’ every estimate set by brokers and investment banks alike. Thus, one should be careful in reading such broker reports. It can be misleading sometimes.

Volatility in earnings, apart from beat ratio, was another aspect focused. The less volatility, the more stable the earnings and easier to forecast and set expectations. HDFC Bank, Axis Bank, TCS, Infosys are some companies with low volatility (measured by coefficient of variation). While volatility maybe low future outlook could be different. For instance, Infosys has recently sounded the caution board and cited that 2013 will be a difficult year for them.
 

 Morgan Stanley cited good fundamentals and consistency of Indian corporate earnings resulting in impressive increase in market capitalisation. The Nifty has returned 432% over the last 10 years, second to only Brazil. Again, this is more of a point-to-point analysis and past market performance without the context of global environment and interest rates and valuation levels, is meaningless. Morgan Stanley concluded by stating, “For investors, it pays to look for the best growth prospects in the market but a look at history will reveal the companies that do with least heart burn.”
 

Read other reports of Morgan Stanley analysed by Moneylife, here.