Market view: 'Disconnect between price and value may sustain for a while'

Kotak expects expect net profits of the Nifty-50 Index to grow 18% in FY2024, 11% in FY2025 and 12% in FY2026

The market’s extreme focus on incremental developments versus fundamentals will add to the challenges of investors as the disconnect between price and value may sustain for a while, brokerage Kotak Institutional Equities said in a note. 

"The Indian economy’s reasonable macroeconomic fundamentals, with solid growth and external position and improving inflation and fiscal deficit, the Indian market’s strong earnings growth prospects over FY2024-26E  and likely decline in global interest rates may result in the large disconnect between price and value across sectors and stocks sustaining for a while," said Sanjeev Prasad of Kotak Institutional Equities.

The brokerage expects net profits of the Nifty-50 Index to grow 18 per cent in FY2024, 11 per cent in FY2025 and 12 per cent in FY2026. Kotak expects banks, diversified financials, IT services and metals and mining to provide bulk of the incremental profits for FY2025 of the Nifty-50 Index.

Valuation summary of Nifty-50 sectors (full-float basis), March fiscal year-ends, 2024E-26E (based on current constituents) 

Point to note: The Nifty-50 is up 22%, the Nifty Midcap Index is up 53% and the Nifty Smallcap Index is up 61% over the past 12 months.

However, Prasad believes the market may find comfort in incremental developments and ignore rich valuations across sectors and stocks for the time being, but this may lead to bigger issues eventually.

"We are not sure whether an ‘incremental’ strategy can generate ‘excess’ returns over long periods, given likely wrong timing (too late at most times) of both entry and exit from sectors and stocks; presumably, more money can be made from a theme when it is still undiscovered (say, housing in 2020-21 versus currently, when a lot of positives regarding the housing cycle are largely priced in and performance being similar to the market’s, while the momentum strategy is working and being much worse on any reversion to the mean," said Anindya Bhowmik of Kotak Institutional Equities.

The brokerage cautioned investors of heightened investment risks from relying entirely or largely on incremental developments as an investment strategy, given the possible large disconnect between price and value being completely ignored under an incremental strategy.

"The  ‘incremental’ argument is valid at all price points and large losses to investors if and when price and value were to converge through moderate-to-severe price corrections and/or time through a period of lengthy time correction; incremental developments may have already been priced in, as is the case with several sectors (automobiles & components, electricity utilities and IT services are the most prominent cases)," said Sunita Baldawa of Kotak Securities. 

Kotak believes most large-cap consumption stocks are trading at expensive valuations, with discretionary stocks at super-rich valuations. "Most mid-cap consumption stocks are trading at expensive valuations, while investment stocks are trading at extremely rich valuations," it said.

Prasad pointed out that numerous midcap stocks have experienced significant gains beyond their fundamental values. 

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd