Netra Report on Tariff Wars and The Gold Put – September 2025 by Sahil Kapoor, Head of Products and Market Strategist at DSP Mutual Fund
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Why Return On Equity (ROE) Is Lower Than Before?
During the 2003–07 economic upswing, Indian companies consistently delivered an ROE of 20–25% and an ROA of 4–6%. Post-Covid, corporate India has entered a similar high-return phase, marked by strong revenue growth, peak margins, and robust profit expansion.
However, a critical question arises: Given the similarly favorable operating conditions today, why are return ratios not as high as before? Where have the higher ROEs gone? One key factor is declining asset turnover. In the earlier cycle, for example, every ₹100 of assets generated around ₹150 in sales. Today, the same investment yields just ₹120–130. Additionally, reduced leverage means these assets are financed more by equity, further diluting returns.
Heightened competition is squeezing profitability, while slowing nominal GDP growth adds pressure. Thus, while the current ~15% ROE appears solid, it lags behind historical peaks. Moreover, sustaining even this level is uncertain. Companies may increase leverage to boost asset turnover, but this hinges on stronger demand visibility—i.e., faster nominal GDP growth.
Why India Commands Premium Valuations
Sectors like FMCG, IT, Auto, O&G, and Consumer Durables rank among India’s most consistent high-ROE performers.
A core group—FMCG, IT, O&G (ex-RIL), and Consumer Durables—accounts for ⅓+ of market cap and earns ROEs ~50% higher than the rest. This underpins India’s long-term valuation premium. However, post-pandemic, cyclical sectors (metals, mining, construction materials) have sharply rerated despite weaker ROE histories.
Meanwhile, earnings momentum in high-ROE sectors has slowed: revenue growth is decelerating, and margins appear late-cycle. Surprisingly, India’s current valuation premium stems from lower-ROE cyclicals, not the traditional high-quality names. Yet, with cyclicals buoying overall multiples, bargains may emerge in high-ROE stocks as valuations cool. Elevated multiples for lower-quality businesses pose a market-wide challenge, creating opportunities for value investors focused on quality.
Current Growth Trend Remains Subdued
India’s FX Reserves—A Warning Signal for External Risks
Mispricing in equities or bonds can sometimes be managed—by holding to maturity in bonds or diversifying across assets. But ignoring a currency at lifetime lows is perilous.
FX markets reflect real and financial flows, and a record-weak rupee amid a non-surging US Dollar Index is notable. As discussed earlier, stagnant FX reserves—despite RBI intervention—signal vulnerability. This warrants caution for spillover risks into bonds and equities.
SMIDs Drive Momentum—But All Factors Eventually Revert
The chart shows momentum factor correlations: blue indicates stronger large-cap ties, orange highlights SMID (small/mid-cap) dominance. Historically, ~⅔ of momentum returns came from SMIDs due to higher allocations. At cycle peaks, SMIDs dominate; during downturns, they suffer most as winners unravel. The past three years’ unprecedented SMID momentum tilt has recently underperformed broader indices. With SMID valuations stretched and momentum still skewed here, the factor faces headwinds.
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