The Indian equity markets have been a subject of intense debate among investors, analysts, and policymakers, particularly regarding their current valuation levels. With the benchmark indices like the BSE Sensex and NSE Nifty 50 reaching all-time highs, a critical question arises: Are Indian equity markets overvalued?

Understanding Market Valuation

Before diving into whether Indian markets are overvalued, it’s essential to understand what market valuation means. Valuation is an assessment of an asset’s or market’s worth, typically based on metrics like the price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and dividend yield. A market is considered overvalued when its prices exceed what is believed to be its intrinsic value, often fuelled by speculative trading or investor exuberance rather than fundamental economic indicators.

1. Price-to-Earnings (P/E) Ratio:

The P/E ratio is a widely used metric to gauge whether a market is overvalued. As of the latest data, the Nifty 50’s P/E ratio is significantly above its historical average. Historically, a high P/E ratio might indicate that the market is expensive and future returns could be lower. However, a higher P/E ratio can also reflect investors’ expectations of strong future earnings growth.

The above chart shows the PE data of various sectors public sector enterprises (PSE) stocks, which are government-owned, got a major boost in the past year. Sectoral indices like Nifty Metals, Nifty Consumer Durables, Nifty Realty, and Nifty Bank have also seen higher earnings. This has driven the PE expansion across major sectors. Nearly two-thirds of sectors are trading at a premium to their 5-year historical average PE.

2. Price-to-Book (P/B) Ratio:

The P/B ratio compares a company’s market value to its book value. A higher ratio suggests that the market is paying more for the book value of assets, which could indicate overvaluation. Currently, Indian markets are showing P/B ratios above their long-term averages, which raises concerns about overvaluation, especially in sectors like banking and technology.

3.Dividend Yield:

This ratio shows how much a company pays out in dividends relative to its stock price. A higher dividend yield indicates significant profit returns to shareholders but might also signal financial trouble if unsustainable. A lower dividend yield might mean the company is retaining earnings for growth or that the stock price is high relative to dividends paid.

4.Market capitalization to GDP ratio:

The market capitalization (map) to GDP ratio, often referred to as the Buffett Indicator, is a financial metric used to assess the valuation of a country’s stock market relative to its economic output. The below table shows the Nifty 50’s valuation metrics over the years.

It helps investors determine whether the stock market is overvalued or undervalued. High Ratio above 100 suggests that the stock market is highly valued compared to the size of the economy. Moderate Ratio is between 50 to 100 indicates a balanced market valuation relative to the economy. Less than 50 indicated undervalued.

Whether Current markets justified?

– The long-term average P/E ratio for the Nifty 50 is around 20. While the ratio peaked close to 40 in 2019, indicating a highly overvalued market, it has now normalized to about 21. This suggests the market is fairly valued. The P/B ratio above 1 indicates a slightly overvalued position, but the consistent dividend yield highlights solid profit distribution.

– Further Mcap to GDP ratio is near or more than 100 in last 5 years indicating the Indian market an overvalued market. It has increased sharply from 2024 to 140 making the Indian market highly overpriced.

Factors Driving Market Valuation

1. Economic Recovery and Growth Expectations:

The optimism surrounding India’s economic recovery post-pandemic has also fuelled stock market rallies. The expectations of robust GDP growth, buoyed by government reforms, infrastructure spending, and a rebound in consumption, have led investors to price in strong future earnings growth. In the past 12 months market cap of global indices increased by 14% while India saw its market cap growth by 40%. India has been the top performer in the global market, followed by US (23%), Taiwan (22%), & Indonesia (17%).

A large number of IPOs, and stock gains have driven the growth of the overall Indian equity market. Indian IPOs raised Rs 98,473 crores in the past year while adding around Rs 6 lakh crores to the equity market cap.

2. Liquidity and FII & DII Investment:

One of the primary drivers of the recent surge in Indian equity markets is the abundant liquidity, as foreign investment has reduced on the other hand domestic & retail investors provide the supports by investing in the markets. The inflow of money into the markets has pushed up stock prices. The easy monetary policy globally has led to excess liquidity finding its way into emerging markets, including India.

3. Corporate Earnings

A critical factor supporting the current valuations is the strong corporate earnings growth reported by several companies, particularly in sectors like Manufacturing, Infrastructure and consumer goods. While earnings growth can justify higher valuations to some extent, The earnings of listed companies are at 5.2% which is indicating towards upward direction but still it is less than FY 2008 which was 6.2%. Nifty delivered 13.5% CAGR returns over the past two decades FY04 – 24 with companies posting 11% earning’s growth during the period. The key question is whether this growth is sustainable in the long term.

Conclusion

Are Indian stock markets overpriced? The current P/E, P/B and M-cap to GDP ratios suggest a slight overvaluation, but the strong economic growth, corporate earnings, and consistent dividend yields present a balanced picture. Investors should remain vigilant, closely monitor market conditions, and consider professional financial advice to navigate these potentially turbulent waters. Balancing optimism with realism will be key in making informed investment decisions in the current environment.

RichVik suggest some key tips for creating a balanced portfolio:

– Spread your investment across different sector or asset allocation such as Large cap, Mid cap & small cap assets to reduce the risk.

– Focus on long-term growth instead of trying to make quick profits from short-term market movements.

– Strict asset allocation as per individual risk investor’s profile.

– Choose funds with a good track record and solid, sustainable growth.

While it is smart to be cautious, the Indian stock market still offers great opportunities for investors who stay informed and make strategic decisions.

To understand more on the topic as well as to start investments please feel free to contact us:

Phone: +91-9324609115

E-mail: team@richvikwealth.in

The article is authored by Mr. Saurabh Gosavi from Team RichVik.