Perma Bull, a long-term investor in Indian markets and someone who has reaped huge wealth from his die-hard optimism and conviction on Indian markets, has been having some sleepless nights. His portfolio has been underperforming badly over the last 1.5 years and his followers are now mocking him for completely missing out on the rally in gold. One follower even made fun of him for being caught in the hamster wheel of stagnation – expending relentless effort on equities, but stuck in the same spot or even moving backwards.
Deciding to keep his current views apart, he fixed a meeting with Doom to give himself a devil’s advocate perspective on the Indian markets and try to understand what he was missing.
Perma Bull: Hey Doom, I am sure you would have felt vindicated after the last two-year stellar run in gold. Since 2022, you have been saying ‘increase allocation to gold versus equities’ and that has played out well.
Doom: Ah, thank you. But I have to admit I have had my share of wrong calls as well. So, we all have our good and bad times in the market. No one is an exception to this.
Perma Bull: Hmm… Anyways, I think your time is up now. With earnings bottoming out and the economy recovering nicely, it’s time for equities to outperform again.
Doom: As I said, everyone will be right and wrong at different times, but the group that amuses me the most is you and your type. Most learn from their mistakes, including people in my cohort, but in your cohort I kind of feel like you just love to forget all the lessons of history when it comes to stock markets. Each Samvat you give a target, that sometimes get hit and most times get missed. You give Nifty earnings growth outlook that also falls in the same category. But each time when you are way off track, as you have been in the last two years, all you do is roll forward the same estimates and targets to the next year as though nothing has changed! I feel you people never acknowledge your mistakes and learn.
For example, you said Sensex will cross 28,000 in 2008 at the start of that year, but Sensex actually went to 8,000 that year and finally crossed 28,000 only in 2014!
One of your friends keeps coming on TV and says Sensex has given 16 per cent CAGR returns between 1980 and now, so it will always give the same returns! I feel like you and other Perma Bulls are irrational sometimes by ignoring base effects, valuation and other fundamental factors like market cap to GDP.
Shouldn’t there be some introspection?
Perma Bull: As you said, everyone is right and wrong at different times. We reserve the right to be wrong as well.
Doom: That is fine, but by excessively pushing equities all the time and selling great stories every time you come on TV with cliched statements, you and your followers miss out on other opportunities.
To be a successful investor, it is important to be open-minded all the time and keep assessing your options. Sometimes, equities are the best bet; sometimes, gold or real estate; and a few times, even moderately yielding but safe liquid investments.
Perma Bull: You are crazy. Are you suggesting investors keep shifting from one asset to the other?
Doom: No, but I am suggesting judicious rebalancing. It is a great tool to reach your financial goals. While one must remain invested across asset classes, when one asset class outperforms significantly, you must dig deeper and identify the factors driving that outperformance and analyse whether the same trend will sustain. Depending on that, you should make changes to your asset allocation.
If you had done this exercise three years ago and understood that a part of the economic and stock market boom then was due to money printing by developed market central banks, you would have been more nuanced in your approach to equities and tried to balance your investments between equities and gold!
Perma Bull: OK, let’s forget the past and focus on the future. I still don’t get why equities may underperform from here. Economy has bottomed out, recent GST rationalisation should give a thrust to consumption, and recent results indicate earnings recovery under way.
Doom: Even I am not 100 per cent sure, but I believe you need to temper your bullishness and plan for the scenario where equities may underperform gold for some more time. I hope you read bl.portfolio article on structural factors in favour of gold in edition dated November 2. I will explain to you what can hold back equities.
Look at chart 1 here on Nifty valuation. For context, bear in mind that this chart reflects the aggregate of Nifty companies that existed in the index in 2019 and today. I have excluded few new entrants to do a clear apples-to-apples comparison.
Perma Bull: Yeah, it is trading at 23.5 times trailing PE. Kind of close to its valuation at the end of FY19. Since then Nifty has returned 144 per cent, or CAGR of 15 per cent. That’s quite a solid performance and makes it clear that you can get similar returns over the next five-six years.
Doom: Really? You are a student of Physics right?
Perma Bull: Yes, don’t get where you are arriving at.
Doom: Define inertia
Perma Bull: It is the tendency of an object to resist changes in its state of motion or rest. An object in rest stays in rest and an object in motion stays in motion.
Doom: Ok, now when does inertia change? Like when does an object in rest or in slow motion move faster or vice-versa?
Perma Bull: When acted upon by an external force. A strong force can increase the motion or bring it to a halt. For example, if you kick a football with brut force, the ball which was in rest moves a great distance. Similarly, applying brakes to a car acts against the force of motion and brings it to a halt.
Doom: Good, if you see a stationary football kicked by the goalie and it travels 90 yards, will you conclude that every time he kicks it, it will travel the same distance of 90 yards?
Perma Bull: Of course not. It will vary according to the force he applies on the ball and also the headwinds and tailwinds while it is in motion each time, like the direction and speed of wind blowing.
Doom: Bingo! You need to view the Nifty valuation in FY19 and now in the same vein.
Perma Bull: Explain more.
Doom: The valuation is similar, but inertia, the forces, headwinds and tailwinds acting on the markets are a lot different today! Between FY19 and now, the inertia of markets got a massive thrust from a few unprecedented fundamental forces and a slew of tailwinds. Corporate tax cuts in FY20 was one of a kind. Then there was the global and domestic liquidity gush when Covid struck, and expansionary fiscal policies across major economies in the world. The tailwinds were so strong and more than countered the severe headwind to businesses from Covid lockdowns in 2020.
A combination of liquidity, fundamentals and sentiment are the forces that power up and push down markets. Multiple forces and tailwinds resulted in the gains of 15 per cent CAGR in the last 6.5 years although Nifty was not trading cheap at 25 times trailing PE at the end of FY19. To forecast returns from now, you need to make objective assessment of forces acting for and against markets. If you do that, you may see the possibility that the current valuation is not cheap, although optically the number is similar as end-FY19.
Perma Bull: How so?
Doom: For one, the biggest headwind for markets is that the best of tailwinds are behind. Consider this – between FY19 and now (trailing twelve month ended June 25), Nifty earnings has grown 182 per cent. Market cap of Nifty has kept track neatly by being up by 144 per cent in the same time. If you see, it is undeniable that equities have kept track with earnings at an aggregate level.
But that is if you look in the rear-view mirror. After all, markets are supposed to reflect expectations of future earnings. Consider one important factor here. During the same period discussed, Nifty revenues have increased only 91 per cent. So, how did profits grow 182 per cent?
Perma Bull: You tell me!
Doom: Expansion of margins. Net profit margin of Nifty companies has increased from 7.8 per cent to 11.1 per cent. What are the factors that drove this, apart from operating leverage?
Perma Bull: Corporate tax cuts implemented in FY20?
Doom: Yes, that was a significant factor. If you check the data in Bloomberg, the effective tax rate (income tax/profit before tax) of the Nifty companies in FY19 was 32 per cent. Today, it is 26 per cent. When you do the math, out of the 3.3 percentage point increase in net profit margin for Nifty, from 7.5 per cent to 11.1 per cent, 0.7 percentage point or more than 20 per cent has apparently come from corporate tax cuts.
Next, consider the other positive factors that played out – clean-up of the banking system that has resulted in surge in bank profits. From very high NPA ratios in FY19, today, bank balance sheets, except in microfinance and few odd banks, are as good as it can get. You can see how much banks have made a difference to the growth in profits by looking at chart 2, which shows the data for Nifty companies excluding financials in the index, such as SBI, ICICI Bank, HDFC Bank, Bajaj Finance etc. The profit growth is only 126 per cent, but the combined market cap of these companies has increased 154 per cent. Their valuation has actually increased from 22 times trailing PE in FY19 to 25 times now.
If you analyse non-financials in the Nifty as a separate cohort, their net profit margins have increased from 7.8 per cent to 10.30 per cent. Based on change in their effective tax rate, corporate tax cut likely contributed to 30 per cent of the increase in net profit margins.
Overall, besides tax cuts, clean-up of the banking system and robust credit growth in FY23/24, formalisation of the economy, post-Covid digitisation boom and benefits of GST reforms over the last decade are major factors that have resulted in margin expansion and boosted earnings growth.
Now, the question to ask yourself as an investor: Is there a scope for margin expansion? I am of the view that while anything is possible, it may be challenging.
Perma Bull: Why so?
Doom: For sustainable increase in margins, you need either structural changes or significant growth in revenue, which will result in operating leverage. Structural changes like corporate tax cuts and benefits of GST rationalisation are largely behind. The most recent rationalisation may help a bit, but likely to be only incremental to a decade of reforms in that space. Certain sectors in India are already the most profitable when you compare with global peers. For example, take the FMCG companies in India, leading players like Hindustan Unilever and Nestle India sport net margins in the 16-17 per cent range versus their parent companies’ 12-13 per cent margins. This has increased from around 12-13 per cent in the pre-GST period of decade ago. Large Indian IT players are way ahead of global peers in profitability. For example, TCS has a net profit margin of 25 per cent as compared to Accenture’s 16 per cent. So is the case in telecom where EBITDA margin is a better measure. Airtel and Jio have EBITDA margins in mid-50s percentage versus AT&T and Verizon’s 35-40 per cent.
At an aggregate level, Nifty net margin, as mentioned above, is at 11.1 per cent and 10.3 per cent excluding financials. For comparison, the S&P 500 has a net margin of 12 per cent now. This 100 basis points lead over India appears to be largely due to lower effective tax rate there. Despite the presence of the world’s leading innovative and highly profitable companies like Nvidia, Microsoft, Meta Platforms etc, their margins would be lower than India if not for the tax rate.
If you want to compare with a similar count of companies, the Nifty 500 has a net margin of 10 per cent.
Perma Bull: Hmm…. that’s an interesting perspective. But I am an eternal optimist and I believe Indian companies will innovate and margins will increase.
Doom: I am also an eternal bull on the Indian economy. But that does not mean I believe the next one percentage point increase in net margins will play out now. For that to happen, Indian companies need to invest more in capex and R&D. When you look at data, the signals are hardly encouraging. Nifty companies invested 8 per cent of revenues in capex in FY19. In FY25, they invested 7 per cent of revenues.
If you see, capex intensity has actually reduced. How are you going to improve your net profit margins by not investing aggressively to innovate? We have also seen how the IT services industry’s focus on shareholder returns, has resulted in lost opportunities.
So, I will wait for signs that Nifty companies are investing more in innovation before making a call on whether margins can improve further. For sustainable improvement in margins from here, look for signs of higher capex/R&D and lesser focus on shareholder returns.
Now, look at chart 4. It indicates how much of Nifty profits came from revenue growth and how much came from margin expansion. Chart 5 indicates how much Nifty profits would have grown if there was no margin expansion and no change in PE.
Perma Bull: What about operating leverage – margin expansion from revenue growth?
Doom: While that is possible, I am concerned about factors that drive revenue. For a company’s revenue to grow, one or a combination of these factors should play out. One, other companies should spend more; two, government should spend more; three, consumers should spend more; four, exports should surge (consumers, corporates and governments of other countries buy more from you).
In aggregate, companies continue to keep a tight leash on costs and capex, government is clear that it wants to reduce fiscal deficit and it is playing out, and exports are getting impacted by tariffs and other global factors. So, these three are clearly going to have an impact on India Inc’s revenue. When it comes to consumers, they were under stress till recently, although the personal income tax cuts and GST cuts may boost their spending. But if you see, three out of the four drivers are not very positive.
It is actually encouraging when the government is managing its budget better by reducing fiscal deficit. Ideally, corporates whose balance sheet today is much stronger than at end-FY19 should take the lead.
So, you could actually say India Inc’s margin expansion today lies in its own hands! Of course, if they invest aggressively, the margin could initially dip and then expand.
Keeping these factors in mind, if I were to invest for the next five years, I would like to factor for risks of margin compression. This is all the more given the fact that 30 per cent of the index is Financials, which is a highly cyclical sector. Any down cycle in the sector could mean margin compression.
The best-case scenario in my view is margins stay around current levels, while the worst-case scenario could be margin compression over the next few years.
In that context, 23.5 times trailing PE is not cheap. And this is not even factoring the global risks.
Perma Bull: What about the global risk?
Doom: Have you heard of Buffett’s statement ‘interest rates act like gravity on stocks.’
Look at how the US 10-year yields have moved since 2007. Specifically focus on the last decade when the yields were well below 3 per cent. Although you may not agree, in my view a good part of the increase in valuation multiples in India’s quality basket was driven by the global fund manager’s hunger for yield.
When sometimes you were getting only 1 per cent on your risk free rate, a high-quality stock trading at 50 PE or earnings yield of 2 per cent (1/50) was attractive. Today, with yields in the US consistently above 4 per cent, this equation has turned upside down.
If you are wondering why FIIs are not buying and selling every other day for months on end, you have your answer here. The US 10-year yield was at 2.4 per cent in March 2019 and below 1 per cent for much of 2020. Today, it is at 4.1 per cent.
So on a relative basis, the same 23.5 times PE of Nifty is much more expensive than in 2019.
Perma Bull: Trump is pressurising the Federal Reserve to cut interest rates more. This will result in same valuation multiples in India getting attractive again.
Doom: Have you checked the data? The US 10-year yield today is higher than where it was when the Fed started cutting interest rates in September 2024. So, Trump pressurising the Fed can actually turn out be counter-productive as inflationary pressures remain there.
Gold outperforming in recent months is partly due to this.
If a 10-year yield goes down there, it may be more due to concerns on economic growth and financially stability risk concerns . Have you heard of the murmurs around risk in private credit there, although that is a separate topic in itself.
So overall, more headwinds (global liquidity tightening, margin expansion largely behind, expensive valuations, geopolitical issues) than tailwinds (economy and earnings recovering) for markets.
Perma Bull: Phew, you drain out all the optimism in me. Why are you all Dooms like this?
Doom: Only you call me Doom. The name I have for myself is Fundamental Analyst. I like to look at the risks and invest accordingly. You like to invest aggressively and in that process you close your eyes to other opportunities around you, like the way you missed the stellar rally in gold.
Anyways what works for you is that bull markets are significantly longer than bear markets. I give that to you.
But once in a while, rebalancing your portfolio and planning for known and unknown risks can work out better in the long run and more importantly, always ensure a good night’s sleep. Never underestimate the importance of that.
Published on November 8, 2025
