Sensex near record, but over a third of it is still available for 'cheap'

The Sensex on Friday closed at 41,010, only 120 points shy from a fresh all-time high. While the benchmark indices are back near record levels, several of its components are still available “cheap”, compared to historical valuations. Business Standard analysed 12-month forward price-to-earnings (P/E) and price-to-book (P/B) multiples of the 30 Sensex components and compared them to the average 10-year P/E and P/B for the respective stocks. Based on the valuation differential, the stocks were classified cheap, expensive, and in-line.
 
According to the analysis, there are 11 stocks in the cheap bucket, 14 in the expensive, and the valuations of the remaining five are in-line with their historical averages. The cheap list is dominated by public sector undertakings (PSUs), such as ONGC, Power Grid, NTPC, commodity companies like Tata Steel, and some automobile and technology companies. The expensive list is dominated by the most blue-chip names, such as Reliance Industries, Tata Consultancy Services, Hindustan Unilever, and Asian Paints. Among the stocks that are fairly valued are Infosys and Bajaj Auto.

On an aggregate basis, the Sensex is trading at a premium to its historic valuation. Currently, the index trades at 19.1 times its estimated 12-month forward earnings, compared to the 10-year average of 15.8 times. Analysts say investors should not be bothered by premium valuations and instead look for stock-specific buying opportunities. “Valuation is no longer a good reason to stay away from India, as we believe that there are enough stock-picking opportunities available with the majority of the stocks trading cheap, even if the market overall screens expensive,” says a report by Investec. The polarisation in the broader market is much more prominent, compared to the benchmark Sensex.
 
“The market since January 2018 has been clearly two-tiered, with 70-80 stocks of the BSE 500 generating positive returns. The focus on ‘high-quality, consistent earnings’ has been the most successful play during this period. The valuation gap between the ‘have beens’ and the ‘has beens’ is now at one of the widest levels,” says a note by IDFC Mutual Fund.
 
Valuations soaring past historical levels indicates investors have rewarded high-quality companies more than their earnings delivery.
 
“Given the slowdown in earnings growth even for the high-quality segment, a substantial part of the returns during the last 18 months has been derived from P/E re-rating,” adds the IDFC note.
 
Some analysts say the run-up in several stocks has priced in strong growth expectations for next year. As a result, the room to gain from the current levels and investor appetite for disappointments will both be limited.