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Growth Bias and Value Prejudice Of Indian Investors

04 September, 2009

History shows that Indian investors have a bias towards “growth” stocks which results in them overpaying for such stocks. On the other hand, they have a bias against “value” stocks. By going long on value stocks and shorting growth stocks, investors can create a high performing market neutral portfolio. 

With perfect foresight we would be able to forecast the financials of all stocks for all years going forward. The bad news obviously is that we don’t have perfect foresight for years going forward. The good news is that we can pretend to that we are sitting in the past, say in FY99 or FY04, and then confidently say that we can predict the future. More importantly, if we go back in time, we can then use data from FY99-09 and use that to calculate the “perfect foresight” value (PFV) of stocks by discounting dividends and then using the current market cap as a terminal value (see Table 1).
Calculating PFV is useful because we can then compare PFV with the prices prevailing for stocks in, say, FY99 or FY04, to understand the market’s biases. We find that the Indian stockmarket (see Figure 1):
• Successfully identifies out/underperformers: we find a ~90% correlation between the premium/discount in past P/E and the “perfect foresight” premium/discount.
• Overpays for “growth” stocks: the market pays a premium of ~50% (relative to the “perfect foresight” value) for “growth” stocks. On the other hand, it puts a ~10% discount (relative to the “perfect foresight” value) on “value” stocks.
• Generates underperformance from “growth” stocks and outperformance from “value” stocks: although the market successfully identified high performing stocks, because it pays such a hefty premium for them, these stocks usually fail to generate strong returns (~10%% negative correlation between FY04 forward P/E and subsequent price performance). The opposite holds true for value stocks – the market’s neglect of this stocks, helps them outperform!

We highlight a long-short market neutral strategy wherein you go “long” on the cheapest ten stocks in India on a forward P/E basis and you “short” the dearest ten stocks (see Table 2). Had you implemented such a strategy on 31st March 2004, you would have generated 90% returns over the 12 subsequent months (whereas the BSE 100 rose a mere 14%). We note the current FY10 P/E premium for “growth” stocks (200%+) and the P/E discount for “value” stocks (65%) is comparable to FY04.


William Sharpe, the Nobel laureate who was one of the creators of CAPM, came up with the notion of “clairvoyant value”. This refers to the value of a stock if we could look forward into the future and forecast (for every year in the future) the financials
of a stock with 100% accuracy.

In a recent article in the Financial Times, Rob Arnott, a noted financial economist, highlighted that this concept, which we call Perfect Foresight Value as it is easier on the tonque, could be used to good effect.

In this note, following in Arnott’s footsteps, we have used PFV in the following manner:

1. We go back in time, say to FY04, and then use actual dividends to calculate the PFV. 1 So PFV in FY04 is equal “present of FY05-09 dividends plus the present value of the stock’s current market cap”.

2. We can then compare PFV with the price of the stock in FY04 to see whether the market can identify winners and losers

3. We can also compare the PFV with the price of the stock in FY04 to see if the market has certain biases which can be exploited.

Note that the data set used in this analysis is the 92 largest stocks in India which were
listed in FY99, FY04 and FY09.

Using dividends we conduct the exercise highlighted above for both FY04 and FY99. We find that the Indian market is good at identifying winners & losers:

• In FY99, we find a correlation of ~20% between premium/discount placed on stocks by the market and the premium/discount justified by fair market value.

(Arnott found this correlation to be 50-60% for the UK market.)

• By FY04, this has improved to ~90%. To some extent this is improvement in the correlation is to be expected given that around 88% of the FY04 PFV is driven by the current market cap (as opposed 80% of the FY99 PFV being driven by the current market cap). However, the extent of the jump in the correlation (from 20% in FY99 to 90% in FY04) also suggests that the efficiency of the Indian market improved between FY99 to FY04.

We rank the top 100 stocks in FY04 as per their forward P/E. We then call the stocks with above average forward P/E, “growth” stocks. If we compare the P/E of these growth stocks with their PFV/E, we find that the market attaches a ~50% premium to these stocks (note: the premium is calculated by comparing the P/E premium to the
PFV/E premium).

We then call the stocks with below average forward P/E, “value” stocks. If we compare the P/E of these growth stocks with their PFV/E, we find that the market attaches a ~10% discount to these stocks.


We have highlighted that market is good at identifying winners, it then overpays very
significantly for these winners. As a result, the FY04 “growth” stocks have produced annualised share price returns of only 20% since 31st Mar 2004 (bang in-line with the BSE 100’s returns i.e. no outperformance at all).

On the other hand, the Indian market underpays for “value” stocks. As a result, these stocks generate clear price outperformance – the FY04 value stocks have produced annualised share  price returns of 33% since 31st Mar 2004 (compared to the BSE 100’s 20% returns). 

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Nitin . 6 years ago

Excellent study. would it be possible for you to share more details on the same. Thanks.

Labanya Prakash Jena . 6 years ago

I am advocate of Value stocks and growth stocks. But I am little doubful over time period of data collection. Most of the stocks growth stocks have been hammered in 2008 and is stiil under recover phase, for example IT, Pharma, real estate. Will this research holds good if we exclude 2008 and 2009? Thanks

Ramesh Damani . 6 years ago

Excellent effort! However, you need to do this for rolling five year periods to avoid a year end bias. I think you will find that the Indian market has rewarded growth at reasonable value. If you take companies with the highest ROIC in each industry, they have tended to do the best. That makes sense if you think about it. Growth is not an issue in India, returns are. Most growth stocks have growth but no profits!

Mitesh . 6 years ago

Interesting study! There is mention of table 1 & 2, which I am not able to locate in the article. Can those tables be shared as well to have an increasing understanding?


Mukund Gajanan Korde . 6 years ago

An interesting hypothesis, no doubt.

There coud be a problem though in identifing growth and value stocks.The issue here is what discount rate to be used for both these stocks?Shall we use a uniform discount rate for both these categories?But the market normally discounts both these categories at different rates.If different rates are used, are we not running into a circulat problem of identifying growth/value stocks before we start discounting.I am sure Prof. Sharpe must have thought about it bu if anyone can enlighten me on this, it will be a great help.

Alpesh Jain . 6 years ago

Great effort. It’s good to see a widely held hypothesis, backed by solid data and analysis.

Growth Bias and Value Prejudice Of Indian Investors

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