Expert view: Niharika Tripathi, the head of products and research at Wealthy.in, believes a sustained rise in real yields would justify some compression in valuation for companies whose cash flows lie far in the future. In an interview with Mint, Tripathi said Indian equities may be absorbing the global bond-yield shock, but it would be premature to conclude that the entire impact has been reflected in valuations. Edited excerpts:
Do the recent moves in global and Indian bond yields materially alter the valuation multiple that the Nifty can sustainably command?
Rising bond yields matter for equity valuations because they increase the return investors can earn from relatively lower-risk assets and, consequently, raise the discount rate applied to future corporate earnings.
The US 10-year Treasury yield has moved close to 5%, while India’s 10-year government bond yield has risen to around 7.1%, making the global and domestic fixed-income backdrop materially less benign for equities.
However, the relationship is not mechanical. The sustainable P/E (price-to-earnings) multiple for the Nifty depends not only on bond yields but also on earnings growth, inflation, the equity risk premium and the quality and visibility of corporate earnings.
A sustained rise in real yields would generally justify some compression in valuation multiples, particularly for companies whose cash flows lie far in the future.
The key issue is therefore whether the current rise in yields proves persistent. If yields remain elevated, the market may increasingly demand a higher earnings yield from equities, putting pressure on P/E multiples.
Conversely, if yields stabilise and Indian earnings growth remains strong, the impact on valuations could be absorbed over time.
In this environment, the market’s ability to sustain premium valuations is likely to depend increasingly on earnings delivery rather than liquidity and multiple expansion.
If the market undergoes a P/E de-rating, what level of earnings growth would Indian companies need to deliver to offset the impact on equity returns?
The arithmetic is straightforward: equity returns are broadly a function of earnings growth plus or minus the change in the valuation multiple.
Therefore, if earnings grow at 15% but the P/E multiple contracts by 10%, the price return would be substantially lower than the underlying earnings growth.
For illustration, if the Nifty were valued at 20.5 times earnings and the multiple declined to 18 times, earnings would need to grow by roughly 14% simply to offset the valuation compression and keep the index price broadly unchanged.
A sharper de-rating to 17.5 times would require earnings growth of about 17% to provide a similar offset. The precise requirement would, of course, depend on the starting valuation and the extent of the de-rating.
This is particularly relevant because the market has already been relying on earnings growth to support valuations. Recent market commentary has put the Nifty’s valuation at around 20.5 times earnings, although estimates vary by methodology and earnings period.
The implication is that higher bond yields leave less room for earnings disappointments. If the risk-free rate remains elevated, investors may be less willing to pay a premium for earnings expected several years into the future.
In such an environment, companies delivering strong, visible and near-term earnings growth could command greater investor attention.
How are Indian equities currently absorbing the global bond-yield shock? Is the impact already reflected in valuations, or are we only beginning to see the pressure build?
Indian equities are already showing several channels through which the global bond-yield shock is being absorbed, but it would be premature to conclude that the entire impact has been reflected in valuations.
The rise in US Treasury yields is occurring alongside higher Indian government bond yields, elevated crude prices and pressure on the rupee – all of which can tighten financial conditions for Indian assets.
Recent reports have also pointed to foreign investors selling amid rising global yields and oil prices.
The important distinction is between an initial repricing and a sustained change in the cost of capital. Equity markets can absorb a temporary rise in yields if earnings expectations remain intact.
The risk becomes more meaningful if higher yields persist and begin to influence corporate borrowing costs, currency expectations, foreign portfolio flows and the relative attractiveness of equities versus bonds.
There are also signs that investors are becoming more selective. The Nifty has faced pressure during episodes of rising crude and bond yields, with some segments with stretched valuations proving more vulnerable.
Therefore, the current phase should be viewed less as a single-event valuation shock and more as a test of the market’s earnings assumptions. If yields remain elevated, further differentiation between companies with strong earnings visibility and those dependent on multiple expansion is possible.
Which sectors or investment styles are best positioned if the market shifts its preference from distant growth expectations towards companies delivering stronger near-term earnings and cash flows?
A sustained higher-yield environment could encourage a shift towards companies where earnings, cash flows and return on capital are visible in the near term.
The relative preference may therefore move away from businesses whose valuations depend heavily on distant growth assumptions and towards companies with stronger balance sheets, consistent free cash flow generation and lower dependence on external financing.
Financials could remain important, particularly businesses capable of maintaining healthy credit growth and margins without a disproportionate increase in funding costs.
Select industrial, capital-goods and infrastructure companies with strong order books and visible cash-flow conversion could also benefit if domestic investment remains supportive.
Consumer businesses with pricing power and predictable cash flows may similarly find favour in a market placing greater emphasis on earnings visibility.
Within the broader market, the distinction between growth at a reasonable valuation and growth priced for perfection becomes particularly important.
Expensive small- and mid-cap stocks can be more sensitive to a rise in the discount rate because a larger portion of their valuation may depend on future earnings.
This does not necessarily imply a blanket shift towards large caps or value stocks.
Rather, the environment could favour quality, reasonable valuations, strong balance sheets, high cash conversion and near-term earnings visibility.
The recent rise in global yields reinforces the importance of valuation discipline, particularly as the risk-free alternative becomes more attractive.
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Disclaimer: This article is for educational purposes only and does not constitute investment advice. The views and recommendations expressed are those of the expert, 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.
