India beats China

New research confirms that fund managers should put their money in Indian stocks, not Chinese ones.

One of the great debates that exercises the minds of fund managers - and will continue do so - is China versus India as a stock investment.

The two countries are rightly viewed as the growth engines of Asia and as key drivers of global trends such as outsourcing and the relocation of manufacturing capacity. Both are also enormous domestic consumer markets (or are tipped to be), with China commanding a population of 1.28 billion people versus 1.05 billion for India.

Historically, India has played the ugly sister to China's Cinderella whenever comparisons have been made. China's greater headline GDP growth and its status as the world's biggest recipient of foreign direct investment have often been used by foreign observers to beat the government in New Delhi.

In turn, the speed of China's economic renaissance since 1979 has been a big reason that India itself has been on a concerted reform path since the early 1990s.

So where does the debate currently stand? After all, the Indian stock market has enjoyed a stellar performance so far this year, and miraculously the government has had a fairly gaffe-free year from the perspective of foreign investors.

CLSA has come out with a research report that puts some hard numbers on the China v India debate. It does so mindful that India is a favourite of its respected strategist, Chris Woods, and China a favourite of its respected economist, Dr Jim Walker (who thinks China will see GDP grow between 9-11% next year).

The report compares the listed stocks of the two countries, splitting them into large cap, mid-cap and small-cap. The executive summary notes: "India beats China in terms of return on equity and corporate governance. Having to choose a basket of large caps and mid-caps the preference would lie with India - better growth forecasts, double the ROE, net cash and better management. For smaller caps the numbers suggest a pretty even race."

Drilling down to the more detailed analysis, the report begins by looking at large caps - defined as those companies with a market capitalization in excess of $2 billion.

In China's case it has 17 large cap companies with a total market cap of $220 billion. India has 16 with a total market cap of $84 billlion. Interestingly, while the Chinese companies have over double the market cap, their daily trading turnover is actually smaller than India's at $340 million versus $428 million.

Both groups are up 30% in the last three months, with the China basket up 51% year to date and the Indian one up 44%. The Chinese basket has a slightly smaller price-earning ratio, suggesting more enticing valuations. However, the report says that the Indian basket has a better growth potential. The Indian basket is forecast to see revenue and earnings per share growth that is double that of the Chinese basket in 2003 and 2004. CLSA expects 12% revenue growth and 16% EPS growth for the Indian basket.

It further adds that the Indian basket has a 30% ROE, which is substantially higher than the 17% of the China basket. It reckons the Indian basket will see a slight rise in ROE next year versus a decline to 14.5% for China's large caps. Meanwhile the Indian stocks are net cash, while the China stocks have a low 10% gearing.

Finally - using its own corporate governance index - it points out that the Indian basket enjoys an average corporate governance score of 67 versus 56 for China.

In the mid-cap field (defined as a market cap higher than $1 billion but less than $2 billion) its China basket comprises 14 companies versus 18 for India. Here the China basket is up 74% year to date versus 42% for India, and the growth prospects are more balanced. However, in respect to ROE and corporate governance, the Indian basket is again an easy winner.

For small-caps (less than $1 billion market cap), the China universe consists of 30 companies versus 35 for India. Year to date the India basket is up 55% versus 51% for China. Here China has more favourable valuations, a similar growth outlook, but again has a lower ROE (13% versus 18%), more gearing and poorer corporate governance. The CLSA report consider the small-cap contest "pretty much a draw".

However, it is clear that India comes out marginally ahead for the mid-cap category and a clear winner in respect to large caps.

In a year in which the Indian economy and stock market have reaped increasing amounts of foreign portfolio investment, this CLSA report will be viewed as further good news for India.

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