Why has corporate profitability not polarised in China?
Focusing on the second question, one possibility that exists is that in China economic growth has been so broad-based that smaller companies have grown faster than the top 20 PAT generators. However, we don’t have in-depth knowledge about the Chinese economy to be able to address this issue in a competent manner.
Focusing on a), the rise in corporate profitability of India’s top 20 PAT generators has been underpinned by the drivers of polarisation, which are rippling through the Indian economy. For example, over the past ten years, the length of roads in India has increased from 3.3 million kilometres to 5.9 million kilometres (CAGR of 6%). The number of mobile phone subscribers has increased over the same period from 392 million to 1161 million (CAGR of 12%). The number of broadband users has increased from 6 million to 563 million (CAGR of 57%). A decade ago, around 44 million Indians were taking flights each year. Now 3x as many Indians are flying each year (CAGR of 13%). 15 years ago, only 1 in 3 Indian families had a bank account; now nearly all Indian families have a bank account.
As a result of this networking of the Indian economy, efficient companies with strong distribution systems have pulled away from regional and local players. For example, as the economy gets integrated, lending, which was once dominated by regional players is now seeing the emergence of a few national leviathans like HDFC Bank and HDFC with both lenders entering the list of top 20 PAT generators over the last 10 years.
The global dynamic is the rise of affordable, easy-to-use enterprise technology which if implemented increases profit margins, reduces working capital cycles, and increases asset turnover. India’s best compounders are using such technology to create wealth for their shareholders.
Implications For Investors
Our research suggests that whilst China is the only other emerging market to rival India in producing consistent compounders, India’s consistent compounders mightily outgun their Chinese counterparts—both on fundamentals and on share prices—due to their ability to use the changes taking place in India to build dominant positions in the Indian market.
China offers a siren call for global investors because of the welcome they receive when they arrive and the speed with which decisions can be made. The process of making money in conjunction with local partners connected to the administration is perhaps not all that different from oiling the political wheels in other countries. It all works well when the assets remain in private hands and benefit from appreciation.
From that perspective, China is more of a private equity market than a stock market destination. India has a vibrant domestic stock market and benefits from better governance which favours the rights of minority shareholders and upholds property rights. That alone helps to highlight why India, despite its political and other challenges outpaces China’s stock market performance handily.
Against a background of deteriorating geopolitical structures India comes out ahead as well.
The MSCI India/MSCI China ratio spent five years ranging and broke out in emphatic fashion in June to reassert the long-term uptrend.