In this edition of ETMarkets Smart Talk, Sandeep Nayak cautions investors against chasing small- and mid-cap stocks trading at steep 40–50x P/E multiples without credible earnings visibility, warning that multiple compression could follow as the market shifts focus from stories to performance.
While he remains constructive on India’s medium-term prospects—backed by expected FY27 earnings growth of around 15%—Nayak believes the next leg of the market will be driven less by events and more by earnings delivery, global liquidity conditions, and sustained FII flows.
He shares his outlook on sectors likely to outperform, key risks to watch, and how investors should position themselves in a stock-picker’s market. Edited Excerpts –
Q) We have seen a rollercoaster ride post-Budget. How do you see markets in the near term?
A) In the near term, markets are likely to remain range-bound with elevated volatility. Post-Budget reactions tend to overshoot on both sides, and we are currently in that digestion phase.
Progress on the US trade deal has helped calm nerves to some extent. However, a key unresolved variable remains the condition around India’s purchases of Russian oil.
How this issue evolves, the US President’s subsequent actions and reactions are key variables to watch, and this may impact market volatility.
That said, the broader market bias remains constructive, and investors will need to adapt behaviourally to tolerate near-term volatility while keeping sight of the medium-term opportunity.Q) With the Budget, trade deal, and MPC behind us, what are the next big triggers?A) As we move beyond Q3FY26, market direction will increasingly hinge on three critical factors:• Corporate Earnings Trajectory: The extent of earnings upgrades or downgrades for FY26–FY27, particularly as consensus estimates get recalibrated post the Q3 earnings season• Global Macro Dynamics: US Federal Reserve policy stance, trajectory of bond yields, and dollar strength—all of which influence risk appetite and capital flows• Foreign Institutional Flows: Whether the recent FII buying represents tactical repositioning or marks the beginning of sustained structural inflowsMarkets will now shift from event led moves to earnings and liquidity driven action.
Q) What is your take on December quarter earnings? Are we seeing green shoots?A) Corporate India’s Q3 report card was uneven but showed promise in key areas. Financials, capital market participants, and select manufacturing and consumption plays delivered solid performance. IT services faced temporary margin challenges, largely due to labour code related regulatory provisioning.
Early recovery signs are visible but not yet broad-based. Q4FY26 results and FY27 guidance will be pivotal in determining whether this evolves into a sustained earnings upgrade cycle.
With consensus expecting ~15% earnings growth in FY27, the fundamental earnings story remains supportive and should underpin a positive bias for Indian markets, despite near-term uncertainties.Q) Which sectors are likely to remain in the limelight in 2026?A) The sectors likely to outperform include:
Banking & financials – strong balance sheets and steady credit growth. Valuations favour leading PSU banks but private banks have consolidated and are making a strong comeback.
Capital markets & asset managers – structural financialisation theme has ensured this sector stays in the limelight. The increase in securities transaction tax has taken the sheen of the brokerages but asset managers and wealth managers look likely to outperform.
Infrastructure, defence, railways – capex visibility remains strong and the leaders in this space look compelling investments from a longer-term perspective.Q) Any theme that looks overheated now?A) Themes where capital has been allocated based on long-term potential rather than near-term earnings visibility are areas of concern. While the underlying secular trends may be valid, current valuations in many cases discount optimistic scenarios without adequate margin for execution risk or growth delays.
Particularly concerning are segments within the small and midcap universe where stocks are trading at premium multiples of 40x to 50x or even higher P/E ratios, despite limited demonstrable earnings track records, unproven business models at scale, or absence of credible pathways to profitability.
Investors positioned in theme-heavy portfolios without earnings backing should expect meaningful multiple compression as the market’s focus shifts from narrative to performance.Q) How should one play the small & midcap theme this year?A) As markets transition from broad-based rallies to a more discerning phase, investment strategy must evolve accordingly. Success will increasingly depend on rigorous selection focusing on companies demonstrating clear earnings visibility over the next 12-24 months, robust cash generation and sustainable free cash flows, and balance sheet strength to weather volatility and fund growth.
Chasing momentum driven trades or investing in narrative heavy businesses lacking fundamental backing is a recipe for disappointment in this environment. Returns will accrue to investors who can differentiate between quality compounders and overhyped stories.
For most investors, accessing this opportunity through professionally managed vehicles such as equity mutual funds or PMS makes strategic sense since stock picking will be the key here.
Q) How are we placed on valuation versus other EMs?A) India continues to command a valuation premium relative to most emerging markets, but this premium is well supported by fundamentals -superior earnings consistency, robust domestic growth drivers, and significantly improved corporate governance standards.
With consensus estimates projecting Nifty earnings per share of approximately ₹1,280 for FY27, the index currently trades at around 20x forward earnings, which is in line with India’s long-term historical average and does not appear stretched given the quality of earnings and growth visibility.Q) How are FIIs looking at India? We are seeing some buying coming back.A) Foreign institutional investors are exhibiting renewed, albeit selective, interest in Indian equities. India’s position as a core structural allocation within emerging market portfolios remains intact.
However, FIIs largely stayed on the sidelines through 2025, driven by concerns over stretched valuations and a pronounced rotation toward US markets, which were perceived to offer superior risk-adjusted returns in that environment.
Recent capital inflows suggest growing valuation comfort in specific pockets and restored confidence in India’s long-term growth trajectory. That said, FII participation will remain fundamentally driven by data and global liquidity conditions rather than sentiment alone.
Sustained foreign flows will hinge on two critical factors: a stable US Federal Reserve policy outlook that supports risk assets, and tangible delivery on Indian corporate earnings growth that validates current market levels.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
