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The Indian stock market generally trades at a premium compared to its global peers on valuation metrics such as price-to-earnings ratio or price-to-book value.

The latest (May 2023) fact sheet by MSCI shows that the Indian market -- represented by its MSCI India Index -- trades at a P/E ratio of 25.6 times compared to 12.9 for MSCI Emerging Markets Index.

Investors willing to buy companies at costlier valuations is a sign that they expect them to grow faster (to justify the premium). And sure enough, Indian markets have outperformed, returning 7.63% over the past 10 years in dollar terms, compared to 1.9% for emerging markets.

Source: MSCI

In such a growth environment, it would be logical to assume that “growth” stocks would have done better than “value” stocks in India over the long term.

Value stocks are those that are trade cheaper on traditional parameters such as P/E or P/B ratios. They tend to grow slower than “growth” stocks, which attract a valuation premium.

But data from MSCI shows that value stocks have done better than growth stocks.

Consider the below data, which shows that value stocks have outperformed growth stocks over each of the past three-, five- and 10-year periods.

But if you compare the year-on-year performance of the value index versus the growth index, a theme emerges. Value stocks tend to better in some environments while growth stocks outperform in others.

As you can see in the table below, growth stocks did better in the earlier part of the last decade while value stocks made a comeback.

Source: MSCI

While stock market returns are a function of number of variables, with fundamentals being the key over the long term, one clear theme emerges when it comes to performance differential between value and growth stocks: interest rates.

Source: New York Fed

As can be seen in the above chart, the Federal Reserve kept interest rates close to zero for several years following the 2008 financial crisis only to start tightening from 2016. It is at this point that value stocks start to outperform.

The outperformance of value stocks continued well into 2020, a year in which markets fell sharply and rebounded equally swiftly, and in 2021. During this period, the Fed slashed its key rate to zero before increasing it sharply again to counter inflation.

The past few years also witnessed several exorbitantly valued tech startups list on the stock market, both in US and India.

Barring the odd exception, most such stocks struggled to do well, as investors decided to put profits above growth prospects.

Year 2022 still proved to a better year for growth stocks. But going forward, will this remain an aberration and will value stocks continue to do well? A hint: watch inflation.

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