Stocks that could gain from 'above normal' earnings

India's broadest stock gauges -the Sensex and the Nifty have rallied more than 25 per cent so far this year, taking Indian equities into a zone that many would consider expensive. The elevated forward PE of the Nifty, and simultaneous gains in stock prices have now prompted investors to question the valuations and the potential upside.

The question has become even more topical as stocks in many emerging markets appear relatively cheaper when compared with those in India. Against this valuation backdrop, domestic brokerage Elara Capital has identified 18 attractive scrips based on the "above normal" earnings growth (AEG) parameters, and the risk inherent in AEG.

Commonly, forward PE is assumed to be positively related to earnings growth expectations, and negatively related to risk. AEG is the difference between earnings growth expectations, and normal earnings growth.

Normal earnings growth is defined as earnings growth minus cost of equity (COE). These stocks are also selected based on other parameters, such as reasonable debt-equity ratio, high earnings quality, ROE > COE, and forward PE that matches forecast AEG even after a 90% cut in the historical AEG.