Market Volatility and Investment Strategies: The Search for Undervalued Stocks

Assessing Market Trends: Bull or Bear?

The financial markets have been highly volatile in recent months, prompting widespread discussions on whether the market is in a bullish or bearish phase. While this debate continues, serious investors are shifting their focus from market speculation to the real opportunity: creating an undervalued and diversified investment portfolio.

A bull market is defined by a sustained rise of over 20%, accompanied by high investor optimism, economic expansion, and strong trading activity. Conversely, a bear market is marked by a 20% decline, fueled by negative sentiment, economic struggles, and low trading volumes.

Between September 2024 and March 2025, the Nifty fell by approximately 15% before recovering around 6% by March 21. These fluctuations indicate that the market is neither in a confirmed bull phase nor a bear market, but instead undergoing a period of correction and stabilization.

India’s Strong Economic Performance Fuels Market Optimism

While short-term fluctuations dominate market discussions, long-term investors should focus on economic fundamentals, which continue to be strong for India.

• India remains one of the fastest-growing economies globally

• Real GDP growth for 2025 is projected at 6.5%

• Nominal GDP growth is estimated at 10.1%

• Declining inflation and interest rates are expected to boost investor confidence

These economic indicators suggest that bear market conditions are not prevalent, and the Indian stock market is poised for mid-term growth.

Analyzing Market Valuations: Nifty’s PE Ratio as a Key Indicator

The Price-to-Earnings (PE) ratio is one of the most critical valuation metrics used to assess whether stocks are overvalued or undervalued. The Nifty50 PE currently stands at 20.8, leading to important questions about market valuation.

Historical trends show that the Nifty PE near 20 is rare:

• June 2022: PE dipped to 20 briefly

• March 2020 (COVID-19 market crash): PE hit 20 but rebounded quickly

• February 2016: A similar occurrence over the last decade

Given that inflation and interest rates are expected to remain low, the Nifty PE is unlikely to stay at these levels for long.

Expected Market Returns Over the Next Three Years

Investors looking at long-term gains need to evaluate earnings yield, GDP growth, and potential PE re-rating to determine future returns.

• Earnings Yield (Inverse PE Ratio): 5%

• Expected Nominal GDP Growth: 10% (conservative estimate)

• Potential PE Re-Rating: If the Nifty PE rises from 20.8 to 23-25, it could result in 10-20% additional returns

Based on these factors, the Nifty’s expected annual return over the next three years could range from 15-18%, assuming stable macroeconomic conditions.

Key Risks to Consider:

• Earnings growth may not match nominal GDP growth projections

• Rising interest rates could prevent PE expansion

• Global market disruptions may impact investor sentiment

Despite these risks, market trends suggest an upward bias for the mid-term.

Constructing a High-Growth, Undervalued Portfolio

While market conditions fluctuate, long-term investors can capitalize on undervalued opportunities by building a balanced portfolio of high-potential, undervalued stocks.

A well-diversified investment portfolio should focus on:

• Stocks with strong earnings potential but undervalued pricing

• Sufficient sector diversification to mitigate risks

• Companies with a high earnings yield and strong revenue growth outlook

Strategic Portfolio Allocation for Maximum Returns

A structured approach to portfolio allocation ensures higher returns with reduced risk exposure.

1. Flexicap Portfolio Strategy:

   • Includes 25+ companies across large, mid, and smallcap segments

   • 35% largecaps, 24% midcaps, 41% smallcaps

   • Target PE ratio range: 11-13

2. Largecap Investment Strategy:

   • Composed of 20+ well-established blue-chip stocks

   • PE ratio range: 11-13

   • Stable earnings growth with moderate growth potential

3. Midcap & Smallcap Investment Approach:

   • Diversified exposure to high-growth emerging sectors

   • Target PE ratios between 13-15

   • Potential for higher risk-adjusted returns

Given their higher earnings yields, these portfolios are likely to outperform the Nifty over the long term, particularly in a low-interest-rate environment.

Investment Strategies for Long-Term Portfolio Growth

To achieve sustainable and high-growth returns, investors should adopt a disciplined investment strategy, focusing on value-based stock selection rather than short-term market trends.