The secret sauce to superior equity returns in India for 40 years

Driven by disciplined capital management and macro stability efforts, the Indian stock market has delivered stellar long-term returns, consistently ranking among the best global performers for 40 years. 

The BSE Sensex has compounded at just over 13.5 per cent annually over the past four decades, making the Indian stock market one of the best performers globally in US dollar terms. Why have Indian stocks done so well? 

The key to high and sustained stock gains is return on capital or equity: The returns investors earn when shares are bought at or below fair value. 

Indian companies, on aggregate, remain among the most disciplined in capital spending and manage some of the strongest balance sheets in the world — the secret sauce to superior equity returns. 

For the foreseeable future, we do not expect this to change. India’s recent macro shifts support sustained equity market performance, underpinned by a focus on macro stability through inflation targeting, fiscal consolidation, and declining oil intensity in the economy. This reduction in inflation volatility has made growth more predictable, lowering India’s equity market beta and lifting valuations. 

Investors accept lower returns when future cash flows are more predictable, like they do for bonds. Fiscal consolidation is creating space for private borrowing and spending to drive the next leg of earnings growth while keeping inflation and its volatility in check. This dynamic is prompting households to raise equity exposure — currently in the high single digits — which could rise materially over the next two decades. We see a structural increase in household equity holdings complemented by higher global allocations to India as its index weight rises. This domestic bid provides a more reliable supply of risk capital, reducing equity volatility and reinforcing predictable growth — a virtuous cycle India has never experienced before. 

India’s recent transformation is underpinned by demographic advantages that ensure a growing consumer market, a social revolution driving lower poverty and greater female workforce participation, improved infrastructure, rising entrepreneurial zeal, and world-class digital capabilities. These factors position India to gain global share and likely account for 20 per cent of global growth in the coming years – making it increasingly difficult for multinational companies to ignore. Energy needs and supply are set to rise rapidly, manufacturing appears to be regaining share in GDP after decades of decline, and credit is likely increasing its share of GDP. This helps keep the earnings cycle trending up. 

The earnings cycle is likely only midway through. An emerging private capex cycle, corporate balance sheet re-leveraging, a robust banking system, and improving terms of trade — via both a higher share in global trade and lower oil intensity in GDP — combined with a structural rise in discretionary consumption provide strong support for earnings. Policymakers’ ongoing efforts to reflate the economy and implement reforms further reinforce this conviction also for 2026. Indian stocks enter 2026 with their weakest relative performance to emerging markets in over three decades, more attractive valuations, and light foreign portfolio investor positioning – a great mix for immediate performance. 

Over the long term, equities will face risks, including adverse geopolitics, sluggish global growth, rising global debt, demographic challenges around the world, low farm productivity, climate change, judicial capacity constraints in India, and disruptive technology shifts via quantum, artificial intelligence, and crypto. The greatest risk to sustaining mid-teen returns, however, is an end to corporate frugality. As India grows more prosperous, future entrepreneurs may not be as disciplined as prior generations, lowering returns on capital and stock prices. Falling inflation and growth volatility make equity returns more predictable — but, by definition, lower too. The base case for us is that the Indian equity market continues to deliver a stellar performance globally, albeit the absolute rate of compounding is likely to be lower than over the last four decades. 

In summary, domestic stocks have delivered strong long-term returns driven by high returns on capital and prudent corporate capital management, making it one of the best performing markets globally. The outlook for sustained equity market performance is supported by macroeconomic stability, fiscal consolidation, and reduced inflation volatility, which together enhance growth predictability and investor confidence. 

The writer is MD and Chief India Equity Strategist, Morgan Stanley