Indian equity markets are buzzing with the talks of higher valuations as nearly 13% of stocks on Dalal Street are trading with a price-to-earnings (P/E) ratio of more than 100 times. Some of these stocks have delivered multibagger returns to investors in less than 12 months.
On the other hand, the benchmark NSE Nifty50 index was trading at a P/E ratio of 23.39 times on July 16 against its 5-year average of 25.44 times.
So, should you be worried in this market? Neelesh Surana, CIO, Mirae Asset Investment Managers (India) said there are pockets of excess in the markets, although the overall market is reasonable.
“Investors should always be cautious of such high P/E multiple stocks because any mismatch between the growth narrative (and thus the high P/E multiple) and actual earnings could lead to a correction either time and/or price,” Surana said.
Anooshka Soham Bathwal, CEO and Founder, Dhanvesttor said, “High P/E ratio generally reflects a case of overvaluation. However, it shall not be seen in isolation. A company’s fundamental performance, its future prospects, and competitive environment shall also be taken into account while arriving at a decision. Current movements of the market have led to some stocks getting in such high P/E zones, which might not be sustainable in the medium to long term. Consequently, we advise caution for investors, while dealing, with such stocks.”
Data available with Ace Equity showed that P/E ratio of companies such as Eraaya Lifespaces, Everest Organics, Kaiser Corporation, Paramount Cosmetics (India), Shalimar Productions, Signatureglobal (India) and Blue Cloud Softech Solutions were above 900 times on July 16.
On a year-to-date (YTD) basis, shares of Blue Cloud Softech have advanced 308% till July 16. On the other hand, Eraaya Lifespace has rallied 602% during the same period.
The BSE Sensex gained 12% YTD, while the BSE Midcap and Smallcap indices advanced 30% and 27%, respectively. Sharing his views on stocks which are trading above 100x, Vaibhav Porwal, Co-founder, Dezerv said, “The expensive valuation multiples signify that risk is higher at this point and the upside potential is limited. At such high valuations, even if a company does well the chances of investors making substantial returns is low. For example, during the dot com bubble, Wipro zoomed over 300x P/E and investors struggled for 2 decades to recover their investment.” When asked how risky these kinds of valuations are, Surana said the P/E multiple is a function of growth rates, return on capital employed (ROCE) and cost of funds. A high P/E implies expectations of very high growth. Generally, the margin of safety is lower and thus risk is high, although there can be exceptions.
Surana advised investors to invest in equities in a disciplined manner within their earmarked asset allocation, with a long-term time frame. “We believe that well-diversified multi-cap/flexi cap or large and midcap categories of fund should constitute a large allocation,” Surana said adding he sees value in large banks and mass consumer-discretionary sectors in this market when the benchmark equity indices are hovering at their record high levels. With a P/E ratio of somewhere between 800x-900x, PTC Industries, Moschip Technologies, Karma Energy, Rajnish Retail, Palash Securities, Medplus Health Services, Surani Steel Tubes, Swojas Energy Foods, Suzlon Energy and GSS Infotech were next in the list.
Surana added that in general, large caps are cheaper than small caps by about 20%. Specifically, in sectors like BFSI, IT, and metals, large caps are preferred. However, due to lack of representation in certain industries, sector leaders in midcaps and small caps should be looked, at for appropriate valuations. Porwal advised investors to bucket the market in three major segments. “High-quality large cap stocks: This sector has traditionally been dominated by FIIs. We still see value there. Sectoral and cyclical stocks: This is where domestic institutional investors are active. We are underweight here and believe thematic investing does not aid wealth creation. Small, micro, and momentum stocks: This segment is dominated by retail investors and we find this space overheated. We recommend you avoid this category,” he said. Porwal also told Business Today that these valuations are risky and may lead to erosions of investors’ wealth. “We are especially concerned about the elevated valuations in the small and mid cap segment of the market. The indices are trading at highly elevated valuations – the mid and small cap indices are trading at 42.33x and 30.7x respectively,” he said adding if the earnings growth is not able to compensate for the high multiples, the risk of price erosion is high and very risky for investors. P/E ratio of Urja Global, Vakrangee, Mercury Ev-Tech, Rajesh Exports, Ind Renewable Energy, The Fertilisers And Chemicals Travancore, Zota Health Care, Sobha and TARC were also hovering above 100x on July 16. Bathwal of Dhanvesttor advised investors to look at spaces where risk-reward is still favorable in the market. Some pockets may still provide some value opportunities and safe spaces such as IT, Pharma, and FMCG may continue to attain their share of the pie in the portfolios of investors.