Pakistan's Stock Boom

Today a report in WSJ stated that the Karachi Stock Exchange 100 index has climbed 32% this year reaching 13274.87 last Friday. The compounded growth rate for the past 2.5 years comes out to be around 35%. This journey of KSE100 is no doubt remarkable despite all the political instability and consistent lack of law and order.

This report included the following passage:

Market analysts predict that Pakistan's stocks will remain attractive because they are significantly cheaper than those in Asian markets such as India, China, Thailand and the Philippines. For the current year, the Pakistani market is trading at a price-to-earnings multiple of 10, "which is a 40% discount to average P/E multiples of other Asian countries," says Mohammed Sohail, director of equity broking at Karachi-based J.S. Global, one of Pakistan's largest securities firm.

I see two major flaws in this reasoning. First, this report does not mention any reason for the 40% discount in P/E. Second, the comparison between Pakistan and other Asian markets especially China and India does not hold because the economic growth depends on sectors that vary among these countries. Furthermore the political situation in these countries is even more different.

For Pakistan, first, the reigns of the government have been tag teamed between democratically elected governments and the Army causing a perpetual instability. Second, although there is a significant influx of foreign capital and remittances, the infrastructure is utterly inadequate for handling economic development. Pakistani government claims that over the past couple of years the GDP growth has been around 7 to 9%, which means that there has been significant economic development. One result of this activity coupled with lack of adequate infrastructure is that the intermittent electricity supply in major cities like Karachi and Lahore. This year the shortage of electricity has been more severe than ever, causing blackouts (known as load shedding in Pakistan) of around 10 to 12 hours at a time as frequent as daily. This is seriously impacting the businesses.

I believe that the low P/E can be somewhat explained when the risks of investing in Pakistan are considered. Since no change in these risks is expected in the near future, the P/E multiple will may not go higher.