For investors in Indian equities, exasperation is the mood. India’s fundamentals are strong, yet share prices have taken an unprecedented knock over the past year. Foreign money has moved out in droves, and domestic flows have somehow managed to hold the bottom.
Global fund managers and stock market investors measure valuation using the forward price-to-earnings multiple. It is the market-to-profit ratio for benchmark indices such as the Nifty 50 or the BSE Sensex. If average emerging markets were trading at a multiple of 10, Indian shares consistently traded at a multiple of 20 or more for years. That is 100% or beyond.
At current prices, that valuation premium has shrunk to the lowest level ever at 18%, according to an analysis by Motilal Oswal, a Mumbai-based financial services firm. By comparison, the long-term average is 73%, and at the peak of the stock market rally in the financial year 2022, it was 147%, according to analysts.
Over the past year or more, money has moved out of India and into a few chosen companies at the forefront of the artificial intelligence value chain in the US, Europe, Korea, and Taiwan. It was mentioned that the three most valuable companies in the world, across America, Europe, and Asia, are microchip manufacturers experiencing unprecedented demand.
Share prices today are a function of tomorrow’s profits. At the moment, investors appear to believe a handful of companies worldwide are the biggest disruptors and creators of value. That means other businesses whose products and services customers continue to buy are unlikely to maintain the same momentum. Heroes of the past are no longer heroes of the future.
Over the years, financial markets have witnessed such concentrated surges. There was an unprecedented rally in technology companies during the dot-com boom of the 2000s. It ended with a bust. Boom-and-bust cycles have also happened in commodities across decades. Oil, gold, and crypto asset firms have all gone through those phases.
Going forward, the situation may look worrying for investors in Indian equities. In every update, global institutions such as the World Bank and the International Monetary Fund are marginally lowering India’s economic growth estimates. However, they continue to believe that India will remain the fastest-growing major economy.
Analysts note that profit growth in India has slowed recently. But a reading of research reports from leading brokerages does not predict gloom or doom. The focus is on riding the AI-led wave while lying low and picking businesses that continue to grow in the domestic market.
What does it mean to you
It is a fact that your SIP returns over two years are now below fixed deposit returns. Many sectors, such as IT services and consumer goods, have underperformed, even though they were once drivers of the stock market. Despite all the negative sentiment toward India, pockets of the stock market continue to trade at significantly high valuations. The government’s unprecedented capital expenditure plan means companies in industrial manufacturing and defence continue to enjoy a significant premium over the average market valuation.
On the other hand, companies in sectors like healthcare, hotels and hospitality, and retail continue to grow at a steady clip. Your challenge is to shed apprehensions about not knowing finance or valuation. Work with your financial advisor or read up on businesses with strong growth prospects in India. Many businesses in India face no competition from global firms due to the market's physical and regulatory characteristics. While historical performance is not a guarantee for future performance, common sense tells you that market valuations tend to level out. Your ability to show patience and hang in there will be tested. Work with an independent financial advisor if you do not have one yet. It is time to up your knowledge game.
