High Hopes, Higher Multiples !

Indian equities remain richly valued, with the mid and small-caps trading well above their respective historical averages. Large-caps, while also premium-priced, offer relatively better value and stability. Earnings growth has been underwhelming, with FY25 at just 3% for the Nifty50 and a tepid start expected for FY26. However, market optimism appears to be riding on ambitious earnings expectations, especially for mid and small-caps, leaving little margin for error. A cautious, bottom-up approach focused on high-quality names, with a bias toward large-caps, is prudent.

Executive Summary:

India’s equity markets have witnessed a remarkable journey over the last few years, driven by a confluence of structural reforms, demographic dividends, robust domestic liquidity, and rising investor confidence. As we look at the current valuation landscape, it becomes imperative to assess whether the optimism is supported by fundamentals or if the market is entering stretched territory.

Even after recent corrections, the Indian equity market continues to trade at a substantial premium. This holds true against both its historical averages and its global peers. However, within this elevated landscape, large-cap stocks present a comparatively more attractive entry point. They appear cheaper than mid and small-cap stocks, a trend evident in both their Price-to-Earnings (P/E) and Price-to-Book (P/B) ratios.

1Y Return USD vs Trailing TTM PE

Source: Bloomberg. Note: Priced as on 31 July, 2025.

	12M fwd. P/E	10Y Median	Prem. / Disc.	TTM P/B	10Y Median	Prem. / Disc.
Nifty 50	20.3x	18.3x	+11%	3.4x	3.1x	+9%
Nifty 100	20.7x	19.0x	+9%	3.4x	3.3x	+4%
Nifty Midcap 100	26.5x	22.9x	+16%	4.2x	2.6x	+61%
Nifty Smallcap 100	25.4x	15.7x	+62%	3.8x	1.9x	+99%

Source: Bloomberg. Note: (1) Priced as on 31 July, 2025; (2) The 12M Forward P/E is calculated using the 12M Blended Forward EPS.

MSCI India 12M Forward PE- Currently trading above its +1SD band

Source: Bloomberg. Note: Priced as on 31 July, 2025.

Earnings: The Long-Term Driver of Stock and Index Prices

In the dynamic world of financial markets, numerous factors influence stock and index prices daily, from economic data releases and geopolitical events to market sentiment and speculative trading. However, when we zoom out and examine the trajectory of asset prices over extended periods: earnings serve as the primary determinant of a stock’s or index’s price trajectory over the long term. The two are closely linked and will always converge.

Source: Bloomberg. Note: Priced as on 31 July, 2025.

Earnings reality yet to catch-up with market optimism:

FY25 saw a subdued 3% earnings growth for the Nifty50, the weakest since the post-Covid recovery, however, consensus expectations are painting a much brighter picture for the next two years, forecasting double-digit growth.
Q1FY26 Nifty50 earnings is projected to remain weak, with a growth of ~5% y/y. This means H2FY26 faces significant pressure to deliver strong results and meet double-digit earnings growth forecasts.
The overall Nifty EPS curve continues to trend downwards for CY25 and CY26, primarily driven by consistent downgrades in the small-cap space. While mid-caps saw some EPS upgrades early in CY25, this trend has reversed, with a -2% EPS change in the last two months. Large-cap EPS forecasts, however, remain broadly unchanged, in the last two months.
With the avg. earnings growth projected at ~20% for CY26/27 for the mid & small-caps, the current valuations offer a very low margin of safety. Failure to meet these aggressive earnings growth estimates can trigger strong price corrections.
In terms of direction of earnings, we note that the LTM EPS for small-caps have seen a de-growth vs. CY24 EPS, which implies that small-caps face a dichotomy of high earnings expectations vs. continued trailing earnings de-growth.

Source: Bloomberg, Valentis Research.

Source: Bloomberg. Note: Priced as on 31 July, 2025.

Nifty EPS BBG Estimates: Small and Mid-caps (SMIDs) priced for perfection

	Dec-24	Dec-25	Dec-26	Dec-27
Nifty 100	1,086	1,113	1,306	1,459
y/y (%)	30%	3%	17%	12%
Nifty Midcap 100	1,385	1,917	2,357	2,735
y/y (%)	2%	38%	23%	16%
Nifty Smallcap 100	660	621	772	924
y/y (%)	14%	-6%	24%	20%
Nifty 500	883	937	1,110	1,252
y/y (%)	25%	6%	19%	13%

Source: Bloomberg. Note: Priced as on 31 July, 2025.

Our Take:

Premium Valuations: Despite recent market corrections, the Indian equity market continues to trade at a premium when compared to its own historical averages and its emerging market counterparts. Nevertheless, large-cap stocks present a relatively more attractive valuation than Small and Mid-cap (SMID) stocks.
Earnings growth challenge: Nifty50’s FY25 earnings growth was a mere 3%, the weakest since post-COVID. While mid-teens growth is projected for the next two years, a weak Q1FY26 (~5% y/y) puts significant pressure on H2FY26 to meet these ambitious double-digit forecasts.
Large-Cap Preference: Right now, we’re feeling more comfortable with large-cap stocks, they seem like a safer bet, especially since small & mid-caps are a bit on the pricey side and more tightly packed. Historically, large-cap underperformance against mid and small-caps suggests a potential reversal, aligning with mean reversion principles (refer chart below). While the broader mid & small-cap indices may face headwinds, a bottom-up approach should be prioritized, with a focus on high-quality companies within these segments that demonstrate strong earnings growth.