Business Standard

Equity overdrive stirs valuation concerns

Market’s superficia­l narrative eclipses fundamenta­ls, say analysts

- PUNEET WADHWA New Delhi, 19 February

Indian equity markets, including the National Stock Exchange (NSE) Nifty 50, Nifty Midcap 100, and Nifty Smallcap 100, are overvalued at current levels, trading much higher than their historical valuations, according to analysts.

As of January 2024, the latest price-tobook (P/B) valuation for the Nifty 50, according to research analysts Varun Lohchab and Amit Kumar of HDFC Securities Institutio­nal Research, was 114 per cent of the average historical valuation, indicating expensiven­ess. When this ratio crossed 100 and touched 103 per cent in 2021-22, the index declined by 1.8 per cent in the subsequent financial year, 2022-23.

“The Nifty Midcap 100 is currently trading at 122 per cent of its historical P/B valuation. The previous peak was in 201415 (FY15) at 129 per cent, after which the index declined by 4.2 per cent in the subsequent financial year (2015-16). Sixtyseven per cent of the constituen­t stocks of the index trade above their historical valuations, surpassing the previous peak of 49 per cent in FY15,” said the HDFC Securities note.

Similarly, the Nifty Smallcap 100 is trading at a P/B of 6.7, the highest since 2012-13.

According to their estimates, the index is currently trading at 149 per cent of its historical P/B valuation, surpassing its previous peak of 125 per cent made in 2020-21. Seventy per cent of the index constituen­ts are trading at a premium to their historical valuations.

‘Dangerous obsession’

In the past year, the midcap and smallcap indices have surged, rallying over 60 per cent each on the NSE compared to around a 23 per cent rise in the Nifty50.

Realty, CPSE, Energy, Auto, Oil & Gas, and pharmaceut­ical sectors on the NSE have been among the key performers during this period, surging 55 per cent to 119 per cent, according to data.

Kotak Securities also believes that the general euphoria on the Street has resulted in a “dangerous obsession” with superficia­l narratives at the expense of fundamenta­ls. The market, analysts argue, is happy to overpay for weak business models and superficia­l narratives without due considerat­ion to fundamenta­ls, risks, and valuations.

Among the larger sectors, the financial sector is the only exception, with most stocks trading at reasonable valuations.

Modest return

That said, in the past decade, this level of overvaluat­ion in midcap and smallcap indices has not always resulted in a sharp index correction in the subsequent onetwo years, HDFC Securities notes, but it leads to a subdued/modest return in the next few years, and the rally tends to get less broad-based.

“It’s time for investors to get more selective and bottom-up across all market capitalisa­tion indices as the phase of easy and broad-based returns might not repeat in 2024-25 through 2025-26,” wrote Lohchab and Kumar in a recent note.

Kotak Securities, meanwhile, does not expect a sharp correction in the markets just yet, and the large ‘disconnect’ between price and value may sustain, notwithsta­nding the rich valuations across sectors and stocks.

This, they believe, could be possible if the Bharatiya Janata Party were to win the forthcomin­g Lok Sabha elections in 2024, and the market was to continue ignoring potential medium-term disruption risks.

“India’s reasonable macroecono­mic situation, possible weak monsoons from El Niño conditions may further postpone consumptio­n and rural recovery. A sluggish global outlook (lower inflation and interest rates), however, should provide some tailwind for the market,” wrote Sanjeev Prasad, co-head, Kotak Institutio­nal Equities, in a recent note co-authored with Anindya Bhowmik and Sunita Baldawa.

In terms of stocks, Kotak Mahindra Bank, Bandhan Bank, Crompton Greaves Consumer Electrical­s, Aurobindo Pharma, and City Union Bank are the top buy ideas of analysts at HDFC Securities.

 ?? Source: HDFC Securities report ??
Source: HDFC Securities report

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