New Delhi: Higher growth expectations but with expensive valuation have more often led to lower returns for investors from equities, DSP Mutual Fund said in a report.
Currently, the P/E ratio of Nifty 50 is at 22.5x. Historically, whenever an investment has been made when the PE ratio is more than 22x, 3-year forward returns have been subdued, the report said.
Thus, an investor contemplating investing in equities with the backdrop of India's growth story should also consider the margin of safety.
The Margin of Safety is an important aspect in equity investing, and the absence of it can cause investors to earn subpar returns. Valuations are one of the key indicators that can help investors determine whether equities have a margin of safety.
There are exceptions as well. In post Covid crisis recovery, equities performed well even though markets were trading at all time high valuation.
However, despite the favorable conditions for engineering and capital goods companies, it is essential to be mindful of valuations. Therefore, a more active, bottom-up approach is necessary for this sector, the report said.
The net interest payments by US corporations are at their lowest levels in half a century. This trend has hit rock bottom, and high-frequency indicators suggest that US corporate profitability can decrease as the cost of borrowing rises and liquidity becomes scarce.
This is likely to cause a headache for US stocks. A similar story is likely playing out in the EU and the UK. Expensive valuations of US equities aren’t helpful in the face of such a headwind, the report said.
The US equity market exhibits overvaluation, indicating the potential for a correction amid economic deceleration, the report said.
The report points to the possibility of a worldwide correction affecting Indian markets, with anticipated milder declines compared to other markets.