Expert view: Indian stock market's valuation rich, earnings recovery key to sustaining gains, says InCred fund manager
At current levels, Indian equities are factoring in a lot of optimism, strong macro tailwinds, and robust domestic flows. However, sustaining gains at higher valuations requires incremental triggers.
After a tepid 5 per cent earnings growth for FY25, the key would be the mean-reversion to a 10-12 per cent trajectory, considering that we are trading at a P/E multiple of 21.7 times FY26.
Q1FY26 will be crucial in determining whether the optimism embedded in prices is justified. Sectors like financials, industrials, and discretionary consumption are expected to post strong earnings due to tailwinds from capex and stable credit growth.
Mid- and small-cap stocks have witnessed earnings downgrades for seven straight quarters, but we believe this phase is over.
Going forward, the improving earnings trajectory is expected to create a more supportive environment for these companies.
If earnings growth surprises to the upside, especially in cyclicals, it can drive markets to new highs.
The spread between India's 10-year bond yield (6.3 per cent) and the US 10-year yield (4.4 per cent) has narrowed to a record low of 1.9 per cent, indicating a significant drop in the risk-free rate.
This coincides with India's risk premium reaching historically low levels compared to other emerging markets.
Simultaneously, global capital is rotating out of the US, as seen in the 9.8 per cent decline in the dollar index, with flows moving into relatively undervalued markets like Brazil, South Korea, and parts of Europe.
India remains a preferred destination for FPIs, with allocations shifting toward areas offering better valuation comfort, namely large-cap financials, PSUs, and export-driven sectors such as pharmaceuticals and manufacturing.
The tariffs on India are expected to be in the 10-15 per cent range, which is favourable compared to most countries.
In contrast, transhipment hubs like Vietnam and Thailand face significantly higher tariffs, positioning India as a more attractive alternative.
As a trusted trade partner of the United States, India offers improved market access for American companies.
Over the medium term, this could encourage increased FPI inflows into sectors like manufacturing, technology, and healthcare, particularly if supported by supply chain diversification and the ongoing 'China+1' strategy.
Such a deal would also signal long-term economic stability and global integration, key factors for long-duration foreign investors.
India's macro backdrop—modest core inflation, stable INR, and manageable fiscal deficit—offers room for the RBI to become more accommodative.
However, with global rates still high and inflation risks (like food prices or oil) lingering, the RBI is likely to be cautious.
A shallow rate-cut cycle could begin in Q4FY25 or early FY26, particularly if the Fed starts cutting.
But it's more likely to be driven by liquidity tools and targeted support rather than an aggressive stance.
The Fed is expected to start cutting rates by late 2025 base case is two to three rate cuts in 2025, but a delay could occur if inflation remains sticky.
Prolonged higher US rates would (i) strengthen the dollar, pressuring EM currencies and gold, (ii) reduce the relative attractiveness of Indian equities due to risk-adjusted return compression, and (iii) trigger FPI outflows, especially from overvalued or illiquid segments.
CRDMO: India's CRDMO (contract research, development and manufacturing) model is structurally benefiting from western supply chain diversification and drug pricing pressure.
As Chinese CDMOs face geopolitical and regulatory risk, Indian firms are becoming go-to outsourcing hubs with superior ROIC profiles.
Consumer discretionary: Driven by rural recovery and premiumisation trends, with the anticipated 8th Pay Commission and arrears payout acting as a potential trigger for increased spending.
Power T&D: With electricity demand expected to double as per capita usage rises, this sector is a quasi-infrastructure utility play with decadal visibility.
PSU banks: Attractive valuations for the large PSU banks, improving balance sheets, modest ROEs and scope for value unlocking in subsidiaries.
We believe earnings growth would revert to 10-12 per cent in line with nominal GDP growth.
We are in an earnings reset environment. FY25 has been marred by tepid earnings growth after four years of 25 per cent earnings growth on a low COVID base.
The second half of the year would be materially better in terms of earnings growth.
Our portfolio remains well-positioned to capture growth opportunities in the current environment.
We continue to focus on identifying high-quality businesses with sustainable competitive advantages and scalable business models.
The focus is on buying a great business with a return on invested capital (ROIC) that is greater than the weighted average cost of capital (WACC).
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Read more stories by Nishant Kumar
Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
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