That Foreign institutional investors (FIIs) are interested in Indian stocks is not something new. The fact that their stakes in large Indian companies have increased over the past few quarters is something that proves this point. On the other hand, the actions taken by domestic institutional investors (DIIs) are quite the opposite. In the year till date, their net outflows stood at over Rs 732 bn. As per the Business Standard, this is probably the highest sold by such institutions in about 9 years; data prior to 2004 is not available. The earlier record was about Rs 570 bn in 2012. On the other hand, the net inflow by FIIs stood at Rs 1 trillion during the year. This is their third highest figure of such inflows reported in a year. 

One may argue that redemption pressures, which may have led to a situation of net outflows by DIIs, must be taken into consideration here. Not to forget the outperformance of other asset classes, coupled with profit booking (with the BSE-Sensex touching its highest levels recently) as reasons for investors pulling their money out of stocks. 

We believe this should ideally be the situation that investors should be taking when the markets seem overheated. Sure, the markets have touched new highs, but does that mean they are expensive? 

Warren Buffett is of the belief that the best single measure for gauging the attractiveness of stocks in an economy is the 'total market capitalisation to GDP ratio'. The lower it is the, more attractive the stocks are in that market. The higher it is, the more expensive they are. 

If one were to view valuations by this parameter, stocks look anything but expensive at the moment. At the end of FY08, the figure stood at about 106%, which indicated an overheated situation. Post the market decline, the figure fell close to 55% levels at the end of FY09. Going by the chart below, valuations picked up quickly thereafter. However, in recent years the ratio has moved lower. As of a couple of days ago, India's market cap to GDP ratio stood at about 64%, which is pretty much close to its thirteen year average. 

Going by this parameter, stocks are not expensive

* As of December 23, 2013; It may be noted that the business daily has estimated the FY14 nominal GDP growth rate to be 12% (5% growth + 7% inflation).

What does this suggest? A short answer would be that one can consider investing in stocks at the moment. 

But when one views valuations of the different indices, it paints a slightly different picture - for the blue chips mainly that is! The BSE-Sensex trades at a multiple of about 17.8 times its trailing twelve month earnings, which is slightly above its long term average. Comparing this to the BSE-500 index, which comprises of the large cap companies in India, valuations are lower at about 15 times. Now, considering that the bluest of blue chip companies form a significant portion of this list of 500 companies - in terms of market capitalisation - it would be fair to assume that the collective valuation for the balance large cap companies would be much lower. 

Also, if one looks at the smaller companies, i.e. stocks forming part of the BSE-Midcap and BSE-Small cap indices, they seem all the more attractive. Given the volatile earnings reported by them in the past few quarters, looking at these companies on a P/E basis may show a distorted picture. But when seen on a price to book value basis, stocks forming part of these indices collectively seem attractive. The price to book values of the BSE-Midcap and BSE-Smallcap indices stand at about 0.67 and 1 times respectively. These are much lower than their long term averages and attractive when gauged in isolation as well. 

Considering the last five year period was one of the most challenging phases for companies, it would be relatively easy to identify the ones that have done well or those that have done much better than their peers. Investors would do well to identify such companies for investment opportunities, especially considering that the markets are not seemingly expensive at the moment.