India is expensive – Really?

June 2025

Greetings from Team Carnelian!!

Inception Alpha
Fund Name Product Subscription Inception 1M 3M 6M 12M 2Yr 3Yr 5Yr
CAGR CAGR
Multi-cap / flexi cap
Capital Compounder AIF closed** May-19 7.7% 21.8% 1.5% 19.0% 35.8% 29.9% 29.9% 23.0% 8.5%
Bharat Amritkaal Fund* AIF open Apr-24 8.3% 17.9% -3.6% 12.0% - - - 10.2% 1.9%
*Capital Compounder & Bharat Amritkaal fund overlap is around ~65-70%.
Bharat Amritkaal fund is also available from Gift City platform for offshore investors.
**Capital compounder is now available in PMS.
Mid & small
Shift PMS open Oct-20 9.3% 16.2% -8.3% 21.7% 34.1% 32.9% - 38.1% 16.3%
Large cap bias
#
Contra PMS open Jan-22 2.6% 13.1% -7.5% 2.7% 37.2% 34.4% - 31.2% 16.5%
Benchmark
BSE 500 TRI 3.5% 14.7% 0.6% 8.5% 20.9% 18.1% 25.1%
Notes:
Data as of 31st May 2025. The above returns are pre-tax and post expenses. Returns below 1 year are absolute and above 1 year is CAGR
# Changed from ‘Carnelian YnG Strategy’ w.e.f. Feb 5, 2025 to reflect evolved investment objective to include contra plays such as businesses facing temporary
headwinds, deep value plays, special situation etc.

“A great business at a fair price is superior to a fair business at a great price.” — Charlie Munger

Valuation is one of those topics that’s frequently discussed, yet it never seems to lose relevance. Have you ever wondered why
one company in the same sector commands a higher valuation than its peers? Or why one market is valued so differently
compared to another?

We often hear about relative valuations, comparing companies within the same sector or against their own historical valuations
and drawing quick conclusions. A common assumption is: A stock with lower valuation multiple is cheaper and therefore better.
But is it really that simple?

Relative valuation often gets a lot of attention, sometimes without a full understanding of its nuances. While it may not be an
exact science, there is certainly a method to madness.

Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]
India is expensive – Really?
June 2025

To understand the concept better let’s delve deeper into the science and art of valuation.

Valuation - The Science

At a conceptual level, the valuation of any asset class including equities should reflect the discounted value of its future cash
flows. This is relatively straightforward in the case of most asset classes with a pre-determined cash flow (e.g. Bonds, Rented
property), but not so easy in the case of Equities.

To arrive at discounted cash flow (DCF), one must estimate a range of future variables such as revenues, profits, free cash flows,
growth rates, the longevity and sustainability of that growth, and perhaps most critically, the terminal growth rate. This requires
investors to make a series of assumptions, judgements and calls on the known unknown.

So, what are the key variables that drive stock valuations? In our view, the most important ones are:
“Growth + Capital Efficiency + Consistency + Longevity”

Growth accelerates the future cash flow - the higher the growth, the higher the DCF value will be when compared to a similar
company in the same sector.

Capital efficiency: after growth, how well a company can generate returns above the cost of capital (discounting rate =risk free
rate + risk premium), will determine the valuation. Highly capital efficient companies get far better valuation than lesser ones.

Consistency: we all understand the power of compounding - A company that grows consistently at 15% with steady capital
efficiency tends to create significantly more value over time than one with sporadic growth. We tend to assign a higher valuation
to a company which grows 15% consistently over 5 years than to one that grows at 18% for 2 years, 10% for the next two and
15% in the final year.

Longevity and Linearity: the longer a company can sustain its growth & capital efficiency, the higher its DCF valuation will be.
What makes it more interesting is the companies with nonlinear growth. These businesses often have back-ended cash flows,
meaning much of their value is realized in the future. As a result, they may appear expensive based on near-term valuation, even
though their long-term potential is substantial.

Example:
Let’s take the example of Trent vs Aditya Birla Fashion Retail Ltd (ABFRL) in the above context
Growth & Longevity: Trent has delivered ~22.5% revenue CAGR over 10 years far ahead of ABFRL ~14.8% CAGR
Capital efficiency: Trent delivered ROCE’s of about ~20% again far ahead of ABFRL’s single digit.
Consistency: Trent has delivered double digit growth in 8/10 years along with >20% RoCEs now vs ABFRL’s double digit growth
in 2/10 yrs. .
This has resulted in Trent trading at 11.9x Price/Sales vs ABFRL's ~1.3x, reflecting superior performance and perception.

Valuation – The Art

If the science of valuation is so well understood, then why do valuations vary so widely?

Valuations are inherently forward looking. When it comes to inputs like growth, capital efficiency, consistency, longevity or non-
linearity, it is the “expected/ forward-looking view” on these variables. i.e. expected growth, expected capital efficiency,
expected consistency, expected longevity / linearity profile.

Naturally, expectations vary widely from one investor to another. These expectations are shaped by individual judgement,
influenced by understanding of opportunity size, competitive advantage, management quality & more.

Judgement is a function of one’s knowledge, experience, personal aptitude, behavioral biases, frame of mind at the
time of assessment and similar non quantitative matters.

Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]
India is expensive – Really?
June 2025

Whenever there is a convergence of expectations of a “majority of investors” towards a “common factor”, we often see
euphoria or pessimism in the market. For example, no one believed in the potential growth of the manufacturing sector or
defense stocks in 2020 and hence most were available at lower valuations. As more and more people developed confidence
around the “expected growth” of the sector/companies, their valuations started inching up hitting euphoria. The same was
witnessed in 2001 with internet companies and in 2021 with New Age companies. In March 2020, everyone was unsure of
growth and stocks tanked, valuations nose-dived. It didn’t matter what the growth eventually would be, but what the expectation
of growth was at that time mattered.

Let’s draw some corollary to the bidding in the IPL. Each season, the auction creates a spectacle where some athletes attract
astronomical bids, driven by perceptions of their potential, marketability, or team fit. Others, despite comparable statistics, may
go unsold, reflecting the varied judgments of team owners evaluating factors like opportunity, competitive edge, and player
reliability."

Why? IPL franchises look beyond current form or performance, prioritizing consistency, pressure performance, adaptability,
fitness, and, crucially, the ability to win. Similarly, just as franchises bet on players who can secure titles, investors back companies
they believe will deliver long-term, compounding returns—not just in favorable conditions but through diverse and challenging
phases."

Investors are willing to pay up for businesses that showcase superior growth, consistency, prudent capital allocation, credible
leadership, and the ability to compound value across market cycles over the long term.

Valuation cannot be determined by focusing solely on one factor. Instead, it hinges on the interplay of multiple factors —
opportunity size, competitive advantage, management quality, and governance — that collectively shape expected cash flows
and discount rates. For instance, some companies exhibit rapid growth but receive lower market valuations due to doubts about
their quality or governance. So, despite growth it remains below desired valuation (we will not say undervalued).

Very often we hear people talking about valuations and finding comfort in perceived 'cheapness,' commonly labeled as value.
But true value, in our view, lies in buying exceptional businesses at prices below their fair value. Margin of safety should be
sought in one’s assumptions about these factors and not just in absolute PE ratios. Hence, we constantly focus on
sharpening the quality of our judgement, assumptions and building sensitivity around the probabilities of various outcomes.
We can’t predict the future with certainty. We can only create scenarios and assign probabilities to them and that’s where our
edge lies. Our edge lies in our differentiated perspective.

One of the most powerful insights we’ve had in this: When you can identify a change in trend before the majority does, you
often find yourself holding a potential re-rating opportunity. This could be a shift in expected growth, an improvement in
management quality, or any factor that enhances the core valuation drivers.

We call these “Magic stocks”

For example, we could identify ICICI Bank in 2019, manufacturing and technology in September 2020, PSU banks in 2022,
Pharma in 2022 etc.

ICICI Bank in 2019 was trading at less than its book value and hardly had any institutional holding. At that time, investors failed
to recognize the change in “expected growth” under the leadership of Sandeep Bakshi which led to a significant re-rating
eventually as more people got convinced about expected growth of future.

Similarly, there was a lot of disbelief in manufacturing in India in 2020 leading to many of the manufacturing stocks trade at low
double-digit multiples. Investors ignored the series of reforms in India and global rebalancing from China which in our view
could re-rate the entire manufacturing sector. Our shift strategy launched in 2020 was specifically designed to invest in
manufacturing & technology, where, based on our estimate, expected growth was accelerating. Over the last 5 years we have
witnessed a significant re-rating of manufacturing stocks with many of them becoming 5-10x driven by a combination of
valuation re-rating and earnings growth.

Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]
India is expensive – Really?
June 2025

Similarly, whenever the majority find comfort in the expected value of these variables in any company/sector (which means they
are obviously trading higher valuations) and if one can identify deterioration in the expected value of these variables,
(negative rate of change) ahead of everyone else, you can avoid a potential loss. e.g. we avoided most owned stocks like Asian
paints, HDFC Bank, Bajaj Fin not because they were bad companies, but we could see the deterioration in expected values of
some of the factors.

Ultimately, what creates euphoria or pessimism is nothing but subjectivity and judgement around future value of these variables.
Now let us extend the above logic when comparing valuation multiples across countries

This brings us to a common question we hear from investors:

“Why is India the most expensive market among emerging economies?” The most frequent comparison is with China.

However, if one considers India as a company and deep dives into factors which determines valuation -
“Growth + Capital Efficiency + Consistency + Longevity”
one would get an answer to this question.

Why should India command a valuation premium to other markets?

There is no country which comes even closer which offers a combination of all the factors pointing in the same direction;
it is the combination of all these factors which determine the premium valuation.

This is the very reason that since 2002, China despite having a high GDP growth has delivered ~4.1% CAGR vs ~12.0%
CAGR for India. ($ based Index returns; for China – Shanghai composite, for India – Nifty)

Microscopic view of India vs other countries

GDP growth Govt. Debt EPS CAGR (%)- ROE (%) -
Country Index P/E - CY25
(%) - CY25 to GDP (%) CY24-26E CY24-26E
United States SPX Index 24.4 1.8 112.4 11.6 18.8
Japan NKY Index 19.6 0.6 215.4 4.3 10.1
Germany DAX Index 18.2 0.3 62.4 8.9 10.0
UK UKX index 14.6 1.1 101.3 2.6 12.9
France CAC Index 16.1 0.6 113.0 5.4 11.2
India NIFTY Index 21.9 6.2 84.0 11.8 15.0
China SHCOMP Index 12.3 4.0 86.6 8.5 9.6
South Korea KOSPI Index 9.5 1.0 52.5 25.1 9.0
Brazil JCI Index 12.6 4.7 39.0 7.7 13.2
Indonesia IBOV Index 8.3 2.0 84.9 5.6 13.5
* Source – GDP growth CY25 - IMF, rest all Bloomberg, EPS CAGR is of relevant country MSCI indices

Indian equities continue to command a premium over both developed and emerging markets, with the Nifty trading at 21.9x
FY26E earnings as of May 30, 2025—well ahead of China, Korea, Brazil, and Europe. This premium is underpinned by India’s
structural strengths: robust GDP “growth” (6.5–7% expected in FY26–27), superior “capital efficiency” (leading ROEs) macro
stability, moderate debt levels (~83% of GDP, mostly domestic), and strong forex reserves.

On “longevity”, India’s demographic dividend, rapid digital adoption, and reform momentum (GST, IBC, PLI) further strengthen
its long-term outlook. India expects to deliver world leading growth during the Amritkaal period regaining its share in the global
GDP from ~3% to ~16%.

In a world grappling with demographic aging, high debt, and policy uncertainty, India stands out as a rare long-term
growth, leadership and governance story, justifying higher multiples. We would be really surprised if India traded
cheaper despite such factors.

India’s valuation premium reflects more than short-term optimism—it is a function of sustained growth, quality earnings, capital
discipline, and a structurally improving macro environment.

Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]
India is expensive – Really?
June 2025

Why should India command more valuations than its historical average:

If one looks at all the input variables of valuation, India offers a far more sustainable and stable growth thereby reducing the risk
premium compared to its historic times. Most structural fault lines of the economy (CAD, fiscal, banking system, inflation and
leverage) are well in control and best at any given time in history. Also, the risk-free rate is the lowest in history, especially when
measured in comparison to the difference in 10-year G-sec between India and US, at ~180bps.

You might find it astonishing to note, a simple 2% reduction in the discounting rate, with everything else remaining the same,
improves the DCF value by ~32-36%. Still expecting and comparing India to the historical valuation range is not the right thing
to do.
Our view and conviction is that India will get further re-rated in the years to come as more players, especially global
investors gain confidence on the expected value of input variables of the Indian economy. Both global & domestic
investors are still underweight India viz its potential.

Valuation, in our view, is not just about numbers—it’s about conviction in outcomes. As long-term investors, we focus on
businesses that deliver more value per rupee invested. We believe India will remain best market for a very long time. We are
lucky to be part of this wealth creation cycle. So are you!

Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]
India is expensive – Really?
June 2025

Awards and recognition

Letters to Investors

• May-25 – The Oracle’s Farewell

• Apr-25 – Steering through the fog together
• Mar-25 – Markets & Maha Kumbh – Exponential India
• Feb-25 – Contra Portfolio Strategy – investing beyond consensus
• Jan-25 – 2025 – Year of keeping low expectations and staying disciplined
• Dec-24 – Beyond Narratives – Is consumption slow?
• Nov-24 – Temporary headwinds amidst structural tailwinds
• Oct-24 - Beyond Narratives…
• Sept-24 - More, New and Better! - India consumption story
• Aug-24 - Carnelian Bharat Amritkaal Series - Infrastructure: Rebuilding India for Amritkaal
• July-24 - Carnelian Bharat Amritkaal Series - Services Exports: Bigger & Better

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Carnelian Asset Management & Advisors Pvt Ltd

1205-1206, One Lodha Place, Senapati Bapat Marg, Lower Parel (West), Mumbai - 13
W: www.carneliancapital.co.in | Tel: +91 22-6937 4100 | Email ID: [email protected]