Markets are overvalued; IT, metals among most expensive sectors: Analysts

As of Jan 2024, the price-to-book valuation for the Nifty50 index, according to HDFC Securities Institutional Research, was 114 per cent of the average historical valuation, indicating expensiveness.

Indian equity markets, be it the Nifty50, Nifty Midcap 100 and Nifty Small-Cap 100, are overvalued at the current levels and are trading much higher than their respective historical valuations, suggest analysts.

As of January 2024, the latest price-to-book valuation for the Nifty50 index, according to Varun Lohchab and Amit Kumar of HDFC Securities Institutional Research, was 114 per cent of the average historical valuation, indicating expensiveness. Previously when this ratio crossed 100 and touched 103 per cent in FY22, the index declined by 1.8 per cent in the subsequent financial year, FY23.

“The Nifty Midcap 100 is currently trading at 122 per cent of its historical price-to-book (P/B) valuation. The previous peak was made in FY15 at 129 per cent post which, the index declined by 4.2 per cent in the subsequent financial year FY16. 67 per cent of the constituent stocks of the index trade above their historical valuations, surpassing the previous peak of 49 per cent in FY15,” the HDFC Securities note said.

Similarly, the Nifty Small-Cap 100 index, they said, is trading at a P/B of 6.7, which is the highest since FY13. 

The index is, according to their estimates, currently trading at 149 per cent of its historical P/B valuation, surpassing its previous peak of 125 per cent made in FY21. 70 per cent of the index constituents are trading at a premium to their historical valuations.

Dangerous obsession

In the last one year, the mid-and small-cap indices have been on fire, rallying over 60 per cent each on the NSE as compared to around 23 per cent rise in the Nifty50 index.

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

Those at Kotak Securities, too, believe that the general euphoria on the Street has resulted in a ‘dangerous obsession’ with superficial narratives at the expense of fundamentals. 

The market, they believe, 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 last decade, this level of overvaluation in mid and small-cap indices has not always resulted in a sharp index correction in subsequent one-two years, HDFC Securities notes, but it surely 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-cap indices as the phase of easy and broad-based returns might not repeat in FY25-26," Lohchab and Kumar wrote in the 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 (BJP) was 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 Nino 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 (KIE), in a recent note co-authored with Anindya Bhowmik and Sunita Baldawa.

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

"On the other hand, stocks that are most stretched vs historical valuations and negative views of analysts are Tata Motors, Nestle India, Titan, and Britannia," Lohchab and Kumar wrote.

Graphic source: HDFC Securities, Institutional Research