‘Earnings yield’ is a simple yet powerful valuation metric.

As the inverse of the P/E (Price-to-Earnings) ratio, it tells you how much a company (or even an entire index) earns relative to its market price. In other words, it reflects the returns generated for every unit of currency you invest.

Right now, India’s earnings yield (taking the NSE 500 universe as the reference) is around 4.1%. To put that in perspective, this places it in the 96th percentile of historical observations (excluding the unusual COVID years). And this suggests that Indian equities are trading at valuations far above their long-term averages.

Supporters of these high valuations might point to India’s relatively strong return on equity (ROE). At present, India’s ROE is roughly 15%, which is certainly robust. Nevertheless, the combination of a low earnings yield and premium valuations probably means the market is already pricing in a lot of optimism.

So investors should keep in mind that if earnings growth slows down even modestly, valuations could revert to more reasonable levels.

For context, valuations are about expectations. A low earnings yield suggests that investors are paying a high price for each rupee of earnings, which is often justified when growth prospects are exceptional. But the higher the price you pay, the more vulnerable you are to disappointment.

Interestingly, as the above table indicates, several global markets today (such as Mexico, Vietnam, and Brazil) offer a more balanced profile: strong ROEs alongside more reasonable valuations. These present potentially better risk–reward opportunities than India’s current setup.

While this need not mean that Indian equities are doomed to underperform, it does mean that Indian investors need to tread carefully and focus on high-quality businesses.

For more actionable insights backed by data and analyses, we invite you to read the latest edition of Netra in its entirety.