Investors need to be wary of overpaying as stock returns are mediocre

At a time when the index appears expensive, a stock-specific approach will serve you well

The Nifty50 index’s price-to-earnings (P/E) ratio is currently at an all-time high of 31.2x its trailing 12-month earnings per share. This is higher than its 10-year (22x) and 20-year (around 20x) averages. Retail investors need to be wary of overpaying for picks in such an environment.

One reason is that the economy has not done well for the past four-five years and Nifty earnings have barely moved. “The fourth quarter of 2019-20 and the first quarter of 2020-21 (FY21) have been a washout for Corporate India. When the base (earnings) reduces, the P/E ratio will look inflated,” says Jatin Khemani, founder and chief executive officer (CIO), Stalwart Advisors.

Instead of relying solely on trailing figures, investors should factor in forward earnings estimates. If earnings recover, valuations will appear less elevated.  

Reasonably valued stocks are still available. “The Nifty P/E is the average figure for 50 stocks. Some stocks within the index are overvalued, many are not. All large-caps are not expensive,” says E A Sundaram, CIO, o3 Capital. Evaluate individual stocks instead of index’s valuation, he suggests.

 

 

Opportunities are still available in the mid- and small-cap segments. “While there has been decent bounce from those lows, plenty of quality mid- and small-caps are still trading at single-digit normalised earnings, or below book value,” says Khemani.

Investors with a horizon beyond FY21 may consider sectors like hospitality and entertainment that have been battered by the pandemic. “Buy the market leaders in these sectors and wait for a couple of years for them to recover,” suggests S G Raja Sekharan, lecturer on wealth management at Bengaluru’s Christ University.

Many investors are debating whether they should sell some quality holdings that have turned expensive. “If a high-quality stock has a 4-5 per cent allocation in your portfolio, hold on to it. But if exposure has grown to 10-15 per cent, prune it,” says Sundaram.

Mutual fund investors should re-examine their asset allocation. “If due to the run-up your allocation to equities has become higher, book profits and bring it back to normal,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.

Seasoned investors looking to add a kicker to their returns may juggle with their asset allocation. “If your advisor has suggested 60 per cent allocation to equities, reduce it to 40 per cent when markets become overvalued. Increase it to 80 per cent when they become undervalued,” says Vinay Paharia, CIO, Union Asset Management Company. Based on in-house calculations, he counsels staying at the advisor-suggested level.