In charts: How 'fair' really are Indian stock market valuations?

Despite a year of record highs, benchmarks Nifty and Sensex have hit a rough patch. What's fueling the unease? It’s more than just foreign triggers — analysts are treading carefully, with concerns over high valuations and mixed signals from both domestic and global fronts.

A robust 24 percent earnings growth in Nifty 50 stocks from FY21 to FY24, along with a surge in retail investor activity—both through direct equities and SIPs in mutual funds and insurance—has driven the stock to overwhelming heights, leading investors to question inflated valuations.

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But how 'fair' really are Indian market valuations? Mid- and small-caps continue to be frothy, and Nifty's price to earnings, or P/E, at 23.5x, is above the historical averages, as the index has risen faster than earnings growth. Ace Equities data shows that the Nifty is trading at a P/E ratio of 24x, which is above the 10-year historical average, while 10-year annualised return is just 12 percent against the over-20 percent returns of the previous market peaks.

If earnings fail to catch up, the market could face correction risks in the medium term.

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Furthermore, Bloomberg data suggests that India’s valuation ranks among the highest globally (at 20.7x), yet its dollar returns over the past year lag behind other major markets. Across the board, only US, albeit slightly, has a higher P/E of 22.

Kotak Institutional Equities highlights a broad-based slowdown among Indian companies, with results falling short of even modest expectations on net sales, EBITDA, and net profits. Consumer firms posted weak volumes, pointing to subdued demand. IT companies reported lacklustre results, with cautious commentary indicating a gradual recovery. Banks, however, showed moderate year-on-year credit growth with stable NIMs and asset quality.

Moreover, valuations in the consumption, investment, and outsourcing sectors are notably high, both on an absolute and relative basis. Moreover, they overlook emerging risks to profitability and volume expectations across these sectors.

However, even as the weak sentiment could linger for a while, not all pockets seem to be pricey. For instance, Nifty Auto presents attractive valuation opportunities for investors, currently trading below its historical averages with a one-year forward price-to-earnings (PE) ratio of 27x, compared to its historical average of 35x, data showed.

Furthermore, the metal sector is trading at relatively low valuations compared to its historical average, weighed down by global headwinds such as sluggish demand and an influx of low-cost Chinese inventory over the past two years. Currently, the sectoral index trades at a one-year forward PE ratio of 19x, below its historical average of 22x.

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