Most Sectors Now Overvalued, Some Stocks Hold Promise

Source and Citation: Most Sectors Now Overvalued, Some Stocks Hold Promise, ET Bureau, Jan 2, 2024

Table of Contents

Analysis for Layman

A report from Kotak Institutional Equities has assessed the fair valuations of the top Nifty50 stocks based on fundamentals. The findings indicate that, except for a few names like SBI, ICICI Bank, Infosys, offering over 10% upside, most leading stocks are currently trading at premiums above their fair values. This suggests that after strong returns in the past 2-3 years, the market may be overheated and vulnerable to corrections that bring share prices closer to intrinsic values.

Impact on Retail Investors

For retail investors, the report raises concerns about likely corrections and volatility in over-owned stocks over the next 12-18 months due to unsustainable valuations. This could impact broader portfolios if timely rebalancing is not performed. However, the analysis also identifies sectors like corporate banks that still offer reasonable risk-reward for those adopting a selective stock approach. Investors are advised to avoid consensus plays in consumer/cement sectors, now vulnerable to downgrades, and focus on stable compounders in financials.

Impact on Industries

From an industry standpoint, sectors like banking and insurance, with strong structural tailwinds, seem better positioned for steady compounding despite current economic vulnerabilities. On the other hand, rate-sensitive sectors like autos/real estate or domestic plays like cement/consumer face growth headwinds due to tight money supply and slow job creation, which may not justify their premium multiples. This situation could prompt sectoral rotations by investors as relative earnings traction and consistency become key metrics.

Long Term Benefits & Negatives

Over the longer term, beyond the current transitionary phase, broader earnings catch-up is probable as capacity utilization levels recover. Growth should return to the historical 7-8% nominal GDP trajectory by 2025-26. This revalidates the structural consumption thesis for domestic cyclicals, albeit with some delay. Recurring capex cycles into infrastructure, housing, and manufacturing should reignite, benefiting capital goods, cement, and allied industries. However, the recent frenzy and extrapolation of peak cycle earnings into perpetuity need moderation through digesting rich valuations.

Short Term Benefits & Negatives

In the near term, moderate stock returns are likely as earnings delivery remains inconsistent against market pricing that surpassed reasonable multiples. Investor expectations require resetting closer to historical levels, around 15-18%, versus the elevated 25%+ recently. Sectors like banks and IT services have demonstrated resilience even in tough macros, making them reliable compounds producing inflation-beating yields. However, quick risk-on rotations at the first signs of peaking rates or China reopening hopes may take hold periodically, benefiting oversold cyclicals temporarily. This calls for strategic profit-taking while avoiding return extrapolation.

Potential Impacts of Kotak’s Valuation Analysis:

Indian Companies:

Gaining:

State Bank of India (SBI): Valuation considered “reasonable” by Kotak, offering potential upside of over 10%. Strong fundamentals, government backing, and potential interest rate easing could further benefit SBI.
SBI Life Insurance: Attractive valuation with over 10% potential return, coupled with growing life insurance market and SBI brand, could attract investor interest.
ICICI Bank: “Reasonable” valuation and potential 10%+ return could draw cautious investors seeking value in the banking sector.
Infosys: Considered undervalued by 23%, offering potential for significant price appreciation due to strong IT sector outlook and global exposure.
Adani Enterprises: Aggressive growth plans and potential benefit from infrastructure spending could attract investors despite Kotak’s neutral valuation.
HDFC Life Insurance: Strong brand, growing life insurance market, and potential 10%+ return could make it attractive for long-term investors.

Neutral:

Large-cap Banks (excluding those mentioned above): Kotak considers their valuations “reasonable” but further upside limited. May appeal to risk-averse investors seeking stability.

Losing:

Companies with High Valuation Discrepancies: Companies like UltraTech Cement, Eicher Motors, Divi’s Labs, Bajaj Auto, Coal India, and L&T face potential downside risks due to significant overvaluation in Kotak’s view.
Mid-cap & Small-cap Stocks with Overvaluation Concerns: Sentiment across these segments could be dampened by Kotak’s overall view of overvaluation, impacting companies like Tata Motors, Maruti Suzuki, NTPC, Hero Motocorp, and others.

Global Companies: