Why m-cap to GDP?
Given that stock prices are derived from expected earnings for companies and the GDP represents consolidated revenue in the economy, this gives an estimate of whether the two are moving in tandem.
How to calculate?
Market Cap to GDP = (Market Capitalization of the Country / GDP of the Country)*100
For Example: The total market capitalisation for all stocks listed on the BSE is Rs135.75 trillion. India’s nominal GDP is Rs 152.51 trillion. This gives us a market capitalisation to GDP ratio of around 89% (this is an improvement from the 55 per cent recorded in 2011, and 151 per cent recorded in the bull market frenzy of 2007).
What the ratio determine?
A ratio used to determine whether an overall market is undervalued or overvalued. As a thumb rule, when the ratio moves well above 100 per cent, stocks are said to be expensive and when it is far below 100 per cent, stocks are assumed to be cheap.
What is the ratio drawback?
The ratio is impacted by trends in Initial Public Offerings (IPOs), as newer companies get listed, this ratio is likely to get impacted. In fact the ratio would go up, even though nothing has changed from a valuation perspective.
Remarks: It is true, the stock prices are derived from expected earnings for companies and the GDP represents consolidated revenue in the economy, this gives an estimate of whether the two are moving in tandem. However, the ratio should be seen more as an indicator and not in isolation. No one ratio is an accurate indication of market valuation. As a thumb rule, if the ratio is above 100%, there is greater need for caution in the markets.
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