The Indian stock market is experiencing what some analysts call "irrational exuberance," with many indicators suggesting that it is overvalued. This situation raises concerns about a potential market crash, especially if an unexpected event occurs.
Current Market Status
On 4th July, the BSE Sensex, a key Indian stock market index, crossed the 80,000 mark and has since remained at that high level. As of last Friday, the market closed at 80,519, and the Bombay Stock Exchange's market capitalisation reached Rs 450 lakh crore. This is 16% higher than its value at the end of March 2024.
Indicators of Overvaluation
Several key metrics indicate that the stock market is overvalued:
| 1. Buffett Indicator: This ratio compares the total market capitalisation of a country’s stock market to its gross domestic product (GDP). India’s current Buffett indicator value is 1.4, much higher than its historical average of 0.89. This suggests that the market is significantly overvalued, even higher than during the 2008-09 Global Financial Crisis. |
| 2. Price-Earnings (P-E) Ratio: This ratio relates the stock price to its earnings per share (EPS). A P-E ratio above 23 indicates overvaluation. Currently, the P-E ratio for the Sensex is about 24.3. For mid-cap and small-cap indices, the P-E ratios are even higher, at 32.9 and 37.9, respectively. |
Risks and Concerns
Analysts warn that the current overvaluation is driven by fanciful narratives and irrational behaviour by retail investors. They highlight the following concerns:
Table of contents [Show] Exaggerated Sectoral Success | Investors often assume that the success of one company implies the entire sector's success, leading to overvaluation. |
Government Statements | Optimistic statements by government ministers predicting continuous market rises contribute to inflated valuations. |
Unsustainable Earnings Assumptions | Many valuations are based on optimistic earnings projections that may not be realistic, especially considering potential delays and challenges in project executions. |
Examples from Defence and Railways Sectors
Defence Sector
From 2020-21 to 2023-24, the revenues of seven major defence stocks grew by 49%, and profits increased by 120%. However, their market capitalisation surged by 306%. For instance, Mazagon Dock Shipbuilders saw a 775% increase in market capitalisation, while its revenue and profit grew by 134% and 285%, respectively.
Railways Sector
Five analysed railway stocks had combined revenue growth of 66% and profit growth of 49%, but their market capitalisation soared by 411%. The Indian Railways Finance Corporation's market capitalisation increased by over 520%, while its revenues and profits grew by 69% and 45%, respectively.
While the Indian stock market appears overvalued based on multiple metrics, some experts believe that it is not in a bubble yet, especially for large-cap stocks. However, the mid-cap and small-cap segments show signs of excessive valuation. Investors should be cautious and consider the potential risks of market corrections. Diversifying investments and being mindful of market fundamentals can help protect you from possible losses in the event of a market downturn.
