Recent reports indicate that Aequitas Investment Consultancy is sounding a note of caution regarding the valuation of Indian equities, pointing to a potential disconnect between market prices and underlying earnings. This concern arises from a perceived decline in earnings yield, a key metric used to assess the attractiveness of stock valuations. The earnings yield, which is the inverse of the price-to-earnings (P/E) ratio, essentially reflects the earnings generated for each rupee invested in the stock market. A falling earnings yield suggests that investors are paying a higher price for each unit of earnings, potentially indicating an overvaluation.
Several factors contribute to this situation. Corporate earnings growth, while still positive, has moderated from the high rates seen in the post-pandemic recovery period. BNP Paribas Exane experts expect that earnings growth is likely to be moderate over the coming years. Sectors such as media and internet software have seen significant downgrades as they struggle to maintain growth. Furthermore, the Indian market has been trading at a premium compared to other emerging markets, reflecting strong domestic flows and increasing retail participation. However, this premium may not be sustainable if earnings growth does not keep pace.
While domestic investors remain active buyers, foreign institutional investor (FII) ownership of the Indian equity market is at a 10-year low, indicating potential for substantial foreign inflows if ownership levels return to the 10-year average. This could provide some support to the market, but it also highlights the risk of outflows if global conditions become less favorable.
Aequitas's concerns align with broader market trends. While India's long-term structural tailwinds remain intact, the current slowdown is cyclical. The economy is projected to grow, but this is slower than the previous year. Forward earnings growth expectations appear lofty considering today's underlying fundamentals. Analysts currently expect Indian earnings per share (EPS) growth in 2025, but this expectation stands at odds with a softening domestic outlook.
The investment firm's cautious stance reflects a broader debate about the sustainability of India's equity market rally. While the Indian economy demonstrates resilience, and domestic factors drive a significant portion of GDP growth, global factors and valuation concerns warrant careful consideration.
