Market Capitalization: An In-Depth Analysis of Valuation Dynamics.

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Market capitalization is a parabolic extension of other valuation parameters like the price/earnings (P/E) ratio. It widens the company’s valuation dimension from net income to the broadest, sales. It is calculated by multiplying the total no. of outstanding shares of the company by the current market price of the stock. This provides the total value of the company governed in the stock market today. Basically, this will be the minimum price an acquirer will have to pay to buy the entire company; otherwise, it is the value the market assures the company based on the current qualitative and quantitative factors. 

Consider an Indian healthcare company (Apollo Hospital) as an illustrative example. It possesses a market capitalization (Mcap) of Rs 74,176cr, comprising 14.4cr shares valued at Rs 5,157 (CMP) per share, dated 7th July. Notably, the company achieved a revenue of Rs 16,612cr in FY23, operating through 48 hospitals with a collective capacity of 9,500 beds. In this case, the Mcap/Sales ratio stands at 4.5x. Furthermore, upon careful examination, the income generated per share amounts to Rs 1,154 (Sales divided by the total number of shares), while the market confidently attributes a multiple value of 4.5 times to each stock.

When considering the situation from that perspective, it may indeed appear to be a lofty valuation. One might question the rationale behind assigning a significant multiple to the total revenue generated. However, it is crucial to view this within the context of the industry outlook and the company’s performance within the sector. If the industry demonstrates a stable and optimistic long-term outlook, and if the company possesses a promising future accompanied by a strong brand reputation, its valuation is reflected in multiples in anticipation of future growth in cash flow. In this case, the hospital industry has been growing at 15% CAGR for the last 5yrs. And the company is the largest player and has been matching the industry’s growth. The outlook for the hospitality business in India is solid due to demographic changes, the rise of the middle class, lifestyle diseases and the penetration of health insurance.

A Mcap/Sales analysis can be performed on peer companies to explicate the valuation dynamic of each stock in the industry. This analysis can even be extended to per bed revenue & profitability detail to elaborate further like gestation period and productivity. Hospital industry has a high gestation period from 5 to 7yrs.

Stocks are categorized based on Mcap. As per the AMFI methodology, the top 100 stocks are classified as large, the next 150 stocks as midcaps, and the rest of the bunch as small caps. Large caps are considered the most liquid and low risk equity asset, and their risk increases as we move towards the small & micro caps.

The Mcap valuation is a very useful parameter to analyze the country level valuation. Here, instead of revenue as the base number, GDP is replaced. Following a similar approach, the Mcap of a country, encompassing the collective Mcap of all listed entities, expands in correlation with the growth and positive outlook of the GDP.

During the period spanning from FY17 to FY23, India’s average Mcap to GDP ratio is 89%. And based on an assumption of 11% GDP nominal growth in FY24, India is trading 10% above the long-term average at 97%. We believe that India will trade at premiumization level given the country’s bright outlook compared to the slowing world. In FY23, India achieved a notable 7.2% real GDP growth, while the US and the Eurozone grappled with recessionary pressures. Looking ahead to FY24, India’s growth is expected to remain robust at 6.5%, surpassing the global growth forecast of 3%. This sustained growth trajectory, bolstered by significant reforms and policy changes, underscores India’s long-term stability with a projected growth rate of +7%, justifying a premium valuation.

Annexure:

(Rs trillion)India GDPIndia McapMcap/GDP Ratio
FY17-1817114585%
FY18-1918915280%
FY19-2020111457%
FY20-21198206104%
FY20-22235265113%
FY22-2327226095%
FY23-24E (@ 11% growth)30229397%

Source: Geojit Research, CMIE

First published in The Economic Times

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