It seems odd to see stocks continuously trending up with the economy plumbing lower. It is tough to argue that companies will do well when the economy isn’t.

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One quick answer to surging stock prices is liquidity, and there is some merit in that argument. With no money headed into productive assets (no one wants to undertake capital expenditure today), the system is likely to remain flush with money.

But let’s leave liquidity out of the picture for the moment and focus on fundamentals.

At a time when no one has a handle on what earnings could look like, it might be wiser to look at the book value per share. A look back in time suggests that at about 2.58 times, the price-to-book value ratio of stocks in the BSE Sensex index is still low historically despite the recent run-up.

In fact, the average price-to-book value (P/BV) of the Sensex since FY1999 has been 3.24, suggesting an over 25 percent upside from current levels. Even if we were to use the median value instead of the average (or mean), the upside would be near 17.5 percent from current levels. These values indicate a Sensex range of between 40,000 and 43,000.

Here, though, we need to be mindful that valuations are also a function of earnings and growth. It is important to note in this context that while the economy may grow at a sub-par rate of maybe ~5% in the coming years versus our earlier aspiration of 7-8 percent, many companies will grow at a healthy pace despite the overall slowdown—after the current wash-out fiscal of course.

Note this: while the economy as a whole will slow, this will offer leaders an opportunity to exploit the conditions for market share gains versus financially weaker and smaller peers. Their focus will also intensify on cost efficiencies. As a result, they will likely emerge stronger and more efficient from the downturn.

Now let us put this in context of the book value. If leaders can continue to deliver a return-on-equity of ~20 percent, this works out to an earnings yield of about 8% -- not bad at a time when interest rates are heading down. What’s more, this yield is expected to grow year-on-year, albeit at a slower pace now. That is what makes many stocks attractive today.

The important point to note above also is that we are talking about best-in-industry companies, i.e., leaders with strong businesses and balance sheets. This isn’t the time to risk your money in second-class companies. Stick to the best, the ones who will survive and thrive through this period of pain.

Kenneth Fisher offered an interesting perspective on this recently in an interview to CNBC-TV18 when he pointed out that for the US investor, India was a small-cap market.

Come to think of it, he’s quite right. Fathom this: the total market capitalization of all stocks listed on BSE is $1.8 trillion, while that of Apple alone is over $1.4 trillion, which is almost 80% of our total market capitalization. Given this, we should see our investments in Indian large caps more as small-cap global growth stocks, smaller than these would be tiny.

To sum up, despite the sharp run-up in stocks, which definitely makes equities vulnerable to a pull-back, there is a case for believing that stock prices may still have some room to trend up over the coming months. More so, if the liquidity stays aplenty.