Broader market remains richly valued despite correction in stock prices

Valuations remain elevated in most segments of the market, including non-financial companies and non-bank lenders
The broader equity market remains richly valued despite recent correction in stock prices, ruling out a pause in selling by foreign portfolio investors (FPIs).

A broader basket of 864 stocks — either part of the BSE 500, BSE MidCap, or BSE SmallCap indices — are currently trading at 29.5x their trailing 12-month earnings, against the 10-year average earnings multiple of 19.5x. The valuations are down marginally from all-time high earnings multiple of 31.2x at the end of March this year.

In comparison, these stocks were trading at 15.6x their trailing 12-month earnings at the end of March 2014. The valuation gap is most elevated in the non-banking finance space, followed by the non-financial sector (see chart).

Analysts attribute this to record valuation of the top index stocks, even though price has corrected significantly in the broader market. “If you exclude the top 15 stocks that are part of the Nifty50 index, most of the smaller stocks (in terms of market capitalisation, or m-cap) look reasonably valued, based on historical averages,” says G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.

This, he says, rules out an across-the-board selling by FPI. Rather it could be restricted to stocks and the sector, where valuations remain on the higher side and is over-owned by foreign investors.

However, even a selective selling in top stocks would bring down the overall market, as the 10 top stocks now account for little over a third of the combined m-cap of all listed stock, while the top 23 listed companies now bring in half of the m-cap.

Valuations remain elevated in most segments of the market, including non-financial companies and non-bank lenders. For example, the non-financial companies are currently trading at 25.5x their trailing 12-month earnings, against the 10-year average earnings multiple of 20.1x. These companies were trading at 17.2x their trailing earnings on average at the end of March 2014.

The non-banking financial companies (NBFCs) however, look most expensive on a historical basis. The sector is currently trading at record high 19.6x its trailing 12-month earnings, against the 10-year average of 12.4x. On price-to-book basis, NBFCs are trading at 2.7x right now, against the historical average of around 2x.

The current valuation in the banking space is in line with the historical average, but analysts attribute this to record low m-cap of loss-making public sector banks rather than a general derating of the sector.  Banking stocks are currently trading at 1.6x their book value (or net worth per share) in 2018-19, similar to their average valuation in the last 10 years.

Analysts say that this could be because 15 of the 34 listed banks have reported net loss on trailing 12-months — one the worst showing by the industry in recent memory.

Nearly 59 per cent of the industry’s combined m-cap is accounted for by the top three private sector banks   — HDFC Bank, Kotak Mahindra Bank, and ICICI Bank — which remain expensive on a historical basis.

Others also say the historical valuation is no guide to the future as Corporate India stares at an earnings downgrade due to a sluggish economy. “We see earnings pressure, especially in the banking space, as interest rate rise is leading to lower margins for lenders. This could bring down the earnings per share for the broader market, putting pressure on stock prices,” says Dhananjay Sinha, chief economist, IDFC Securities.


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