Why exceptional equity returns have ended 

In my thirty-year career as an equity investor, there have been phases where it was very difficult to make money. For instance, there was a seven-year spell between 2007 and 2014 when monthly SIPs into equity funds felt like funneling money into a black hole. No matter how much I invested, my portfolio value wouldn’t budge! 

The last five years have been the exact opposite of that period. It has been ridiculously easy to make money. With stock markets soaring relentlessly, all kinds of investors – whether newbie or seasoned, active or passive, largecap oriented or microcap – have made big money. This is how trailing returns look now (November 17 2025). 

These returns have made many folks supremely confident that returns of 16% to 25% CAGR are quite normal in the stock markets and that they will continue. But this belief is as flawed as the view in 2013 that FDs were better than equity funds! 

If you invest in equity products today expecting returns of 16-25% to continue, you are in for disappointment. We believe that the last five years marked an exceptional period for the Indian stock markets and that returns will moderate from here on. Here are five reasons why. 

# 1 There’s no low-base effect

When you look at trailing returns on any asset, the starting point and the ending point make a big difference. The stellar equity returns we see today are a function of the very low base that the Covid crash created five years ago. 

Starting period for trailing 5-year returns on the index or equity MFs today is November 2020. In November 2020, Indian markets were still reeling from the Covid crash. Therefore, the Nifty50 was at 12800 levels (26000 today), the Nifty Midcap 150 was at 7200 (22400 today) and the Nifty Smallcap 250 was at 5600 levels (16950 today). 

In contrast, Indian indices today are hovering close to their lifetime highs, with the Nifty50 and Nifty Midcap 150 within a whisker of their life highs, while the Nifty Smallcap250 is about 8% short. Returns from this starting point obviously cannot match returns starting from Covid lows. 

# 2 Earnings growth is turning selective 

When they read stock prices are slave to earnings, many investors treat this as mere theory. The truth is that stock market returns in India have faithfully mirrored the profit growth of listed companies in the past decade. Index and equity fund returns in India have been exceptional in the last five years, because a low-base effect has also operated on the economy and corporate earnings. 

The tables below show that as the Covid lock-down started in Q4 FY20 and lasted into Q1 FY21, there was a contraction in India’s GDP and corporate earnings. As Covid fears receded, the economy rebounded. The exceptional growth between FY22 and FY24 was partly the result of a low base. As the base effect has waned, the economy has returned to its long-term growth rate of 6.5-7%. 

Corporate earnings have followed the same trajectory, contracting in Q4FY20/Q1FY21 but then showing high growth on the low base. Trends in per share earnings of the Nifty50, Nifty Midcap 150 and Nifty Smallcap 250 index constituents are shown below. 

The table below breaks down the last five years into a high-growth and low-growth period and captures index returns in both periods.

The data shows clearly that the big index returns of 25-43% between 2020 and 2024 were accompanied by earnings growing at a similar pace. As earnings growth slowed to single digits from FY25, index gains have also slowed. Midcap stocks are the only exception to this trend. They have continued to deliver strong earnings growth, while stock prices have been slow to rise.  

Going forward, equity returns will continue to track earnings growth. Q2 FY26 has brought some signs of returning earnings growth. However, the revival is patchy with a few sectors contributing disproportionately to earnings growing in the double digits. It is clear that the 35-40% earnings growth managed by mid and small-cap companies in the four years after Covid period were exceptional. The sharp corporate tax cut (from 33% to 22%) in September 2019 also propped up that growth. Without these one-off factors to lift earnings, we will likely see more volatile earnings performance. This points to selective sectors and stocks doing well, rather than the market as a whole soaring as it did post-Covid. 

# 3 Valuations are demanding 

When companies deliver exceptional earnings growth for a while, markets begin to believe that this is the new normal. This has definitely happened with the Indian markets, where market valuations have climbed materially post-Covid. As we write this, the Nifty50 trades at a PE (Price earnings) of 22.5 times trailing earnings,  higher than the long-term average of 18 times. Long-term earnings growth for Nifty50 companies is in the 14% range. 

Valuations in the mid-cap and small-cap spaces are even richer at about 34 times and 30 times respectively. These valuations presume that the post-Covid purple patch in earnings will continue for these smaller companies. Given that smaller companies are more vulnerable to commodity price swings, global challenges and other macro challenges, this expectation seems unrealistic. We can see from the above table that small-cap companies have already struggled to deliver earnings growth in the past year with a 2.8% earnings growth from June last year. Mid-cap companies have sustained strong earnings growth of 35%. This justifies their PE for now, but it needs to continue for the recent rally to sustain.  

We believe that going forward, small and mid-cap segments will see only select sectors and companies meet the growth expectations embedded in their PEs. We also believe that the sectors that may outperform over the next five years may be very different from those that led the post-Covid rally. This calls for being very selective with one’s stock choices, especially in the small and mid-cap segments of the market. 

# 4 Liquidity boost waning 

If Covid created a low-base effect for growth, it also proved an inflexion point for the liquidity flowing into stock markets. As interest rates plunged during Covid, retail investors started to pour money into stock markets in the hope of better returns. As the market rose steeply from the Covid bottom, these investors were proved right and reaped big money from their equity bets. This has led to a virtuous cycle where the domestic money flowing into stocks and equity MFs has turned from a trickle into a flood. Between FY19 and FY25, for instance, the annual SIP flows into MFs trebled from about Rs 92,700 crore to Rs 2.89 lakh crore. 

As the table below shows, this flood of money from domestic institutions (mainly MFs) and retail investors has more or less kept up, irrespective of market movements and the  FPIs’ (foreign portfolio investors) on-off sentiment in the last three years. Consistent domestic money flowing into equities has put a floor to market falls in India, preventing sharp declines whenever FPIs have pulled out.

Going forward, with FPI holdings in Indian stocks already at a 15-year low, it seems unlikely that the barrage of FPI selling will continue. However, the domestic money flowing into stocks and equity MFs is likely to grow at a far slower pace or flatten out. This flow may grow gradually with incomes, but the 5X surge post-Covid will clearly not be repeated. Therefore, the boost from domestic liquidity which contributed to the rerating of Indian stock markets is likely to wane over the next five years too.  

# 5 Markets always mean revert

So, if returns of the past five years were exceptional, what returns should equity investors expect from here on? Returns for individual stocks will clearly track earnings. However, earnings at the market level are hard to predict. Therefore, investors are better off relying on history. 

Mean reversion is a very powerful force in the markets and eventually decides long-term returns from assets. Therefore, we ran a rolling return analysis on the key indices over the last 30 years, to arrive at the long-term returns that investors can reasonably expect from the large-cap, mid-cap and small-cap segments. Broadly, over a three-decade history, large-cap indices have delivered a 5-year CAGR of 12.4% and mid-cap and small-cap indices have managed about 14%.

The table below also indicates that when past returns are as high as 16.5%, returns that markets deliver for the next 5 years are usually in the single digits. On an average, if the Nifty50 delivered a 16.5% CAGR in a 5-year period, it averaged just a 7.2% CAGR in the next five years. The table also lays down the probability of making 5-year CAGRs of 16% or 20% from different indices, going by history. 

Below is a useful tool designed by Bipin Ramachandran for you to understand how markets behave after a high return period. In this tool, you can input any number on past 5-year returns. Every time the Nifty 50 or Nifty 500 delivered these returns, the tool will calculate what the average return of the succeeding 3-year or 5-year period would have been. It will also calculate the probability of the next 3 years or 5 year period generating the same (or higher) level of returns you inputted.  

Index Return Analysis

Takeaways

So what should you conclude from the above analysis?

When past returns from equities are this high, it is best to temper your future expectations. If you are investing or making financial plans today, do not budget for index-level returns exceeding 13%. 

• Stock prices in India have closely tracked earnings growth. Select sectors and companies are still delivering good growth. Stock price gains from here will therefore be based on which sectors and stocks are able to deliver growth that meets expectations. 
• The four-year spell of exceptional growth has led to stock valuations taking high growth for granted. Stocks will therefore correct if their growth disappoints. At a broad level, small-caps are more vulnerable to such disappointment than large-caps. Mid-caps are expensive too, but their earnings growth so far has held up at the index level.  
• The returns of 16%-25% that you have made on your stocks and MFs since Covid are exceptional. These returns were the result of the low-base effect of the market itself as well as the contraction in corporate earnings in FY20/21, and corporate tax cuts. The returns over the next 5 years will need to be made on a much higher base. 
• Returns in the last five years have also come from domestic liquidity flooding into stocks. SIP money has put a floor to market falls and offset FPI selling. But domestic liquidity growing at an organic pace from hereon cannot trigger a repeat of last five years gains. For this, we need a return of FPIs – and FPIs will again look for signs of earnings growth and higher GDP before investing in India. 
• The category and sector stock/MF choices you made over the last five years have delivered great results so far. But the next five years will be different. This will call for different allocations and choices. While we will incorporate this into our current recommendations, we are also working towards helping you manage your portfolio in a more professional way. We’ll give more details on this in the coming days!