India stocks: Equity Risk Premium

Wednesday, November 19, 2008

In case  some of you are wondering about my 20% discount rate in the post: India Stocks: Bank Nifty offering good value

I have used the work of Varma/Barua June 2006 where good work was done in re-creating data series to allow a robust calculation of an equity risk premium for India.  They came up with 12.5% ERP and I have used a 7.5% risk free rate going we have a 20% discount rate.

The overall indices can also be ball-parked using this method.  If we assume:

  • 10% reduction in EPS for the indices in 2009-2010
  • 15% earnings growth rate for next 10 years and 10% thereafter
  • Discount rate of 20%
Then we get the following fair values for the Indices:
                        Nifty   2460     Sensex     8600

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