FPI inflows don't tell the full story: Why earnings and valuations matter more for investors

Foreign portfolio investor (FPI) inflows often grab headlines and are widely seen as a barometer of confidence in Indian equities. However, market experts caution that investors should avoid using FPI activity as the sole basis for investment decisions, as earnings growth, valuations and sector-specific trends ultimately play a much larger role in determining stock performance.

According to Karan Aggarwal, Co-Founder and Chief Investment Officer of Ametra PMS, FPI flows are largely driven by a combination of earnings expectations and valuations rather than market sentiment alone. As a result, blindly following foreign investors into or out of stocks can lead to poor investment decisions.

FPI money isn't spread evenly

One common misconception is that positive aggregate FPI inflows benefit the entire market equally. In reality, foreign investors tend to concentrate their allocations in large-cap companies, while mid- and small-cap stocks remain more dependent on domestic institutional flows and retail SIP investments.

Aggarwal notes that mid- and small-cap indices are currently trading at price-to-earnings (P/E) multiples in the mid-30s. Such valuations, he says, can only be justified if companies deliver earnings growth of around 20-25% in FY27, leaving little margin of safety for investors if earnings disappoint.

This means that even if foreign investors continue buying Indian equities, it does not automatically imply sustained gains across all market segments.

Valuations and earnings go hand in hand

Aggarwal points to the previous wave of FPI buying in April 2025 as an example of how foreign investors assess opportunities.

At the time, market valuations had corrected nearly 20% from their 2024 highs, and expectations of RBI rate cuts had improved the outlook for corporate earnings. The combination of lower valuations and improving growth prospects made Indian equities attractive to overseas investors.

Today's market looks different. According to Aggarwal, the Nifty is trading at around 20 times consolidated earnings while earnings per share (EPS) growth for FY25 stands at about 5%, resulting in a price/earnings-to-growth (PEG) ratio of around four—well above the normal range of one to 1.5. This suggests that valuations are running ahead of earnings growth, making stock selection increasingly important.

Sector-level analysis is crucial

Experts say investors should also examine sector-wise flows instead of looking only at headline FPI numbers.

For instance, banking stocks currently trade at valuations below their historical averages. However, Aggarwal notes that the sector's core earnings growth has slowed from nearly 20% a few years ago to around 4-6% in recent years. This moderation, he says, has led to Indian bank valuations gradually converging with those of global peers.

The takeaway for investors

Rather than chasing stocks because foreign investors are buying them, investors should focus on the underlying fundamentals. Earnings revisions, reasonable valuations and sector-specific growth prospects provide a more reliable framework for portfolio allocation than headline FPI data alone.

While FPI inflows remain an important indicator of global investor sentiment, they are only one piece of the puzzle. As Aggarwal suggests, investors who adopt the same earnings-and-valuation approach followed by institutional investors are more likely to make informed, long-term investment decisions.