Wait for valuations to correct further before you buy market favourites

The market correction appears to be gathering momentum. The Nifty is down 5 per cent since Budget day and 2.1 per cent over the past three months. 

Mid- and small-cap indices have been hit hard, declining 8.9 per cent and 12.2 per cent, respectively, over the past three months.

However, instead of panicking, investors could view the current market correction as an opportunity to purchase quality stocks, which are usually too expensive when the going is good.  

One key reason for the ongoing correction is the crisis among non-banking financial companies (NBFCs). “As NBFCs’ cost of funding moved up and refinancing debt became difficult, they slowed down lending. This hit the financing of consumer durables, auto and housing, among others, hard. Medium and small enterprises, which depend on NBFCs for credit, have also been affected,” says S Krishnakumar, chief investment officer-equity, Sundaram Asset Management Company. 

Several high-frequency indicators, financial results and management commentary of consumer-oriented companies point to an economic slowdown. If the monsoon’s progress remains lacklustre, it could dent rural purchasing power further. In the absence of any stimulus from the government, the economy may take some time to course-correct.

The tax surcharge on the super-rich, which has affected a large percentage of foreign portfolio investors (FPIs), has affected sentiment adversely. “Instead of increasing the tax base, the Budget continued to increase tax rates on high net worth individuals and FPIs,” says Jatin Khemani, founder and CEO, Stalwart Advisors, a Sebi-registered independent equity research firm. Foreign institutional investors have pulled out Rs 6,170 crore from the Indian equity market since Budget day. For investors who can hold their nerves, such market declines spell opportunities. Experts see value in the mid- and small-cap space, owing to the correction since January 2018. “At the current market valuations, we expect a portfolio of quality small- and mid- caps accumulated over the next few months and available at below historical average valuations to outperform the broader markets, including large-cap bluechips, over the medium term,” says Nilesh Shah, MD, Kotak Mahindra Asset Management. 

In the past, the rally was very narrow, with select growth stocks getting driven to very high valuations. While the correction will bring down the valuations of these market favourites, it remains to be seen if they will become attractive enough. “Wait for expensive names to correct further before you buy them,” advises Kumar. Khemani, too, suggests caution. “While one should pursue growth, it should be available at a reasonable valuation,” he says. He suggests looking for quality businesses outside the Nifty that are available at more reasonable valuations and investing in them in a staggered manner.

Kumar sees value emerging within the NBFC sector. “From the 3.5-4 times book value, many quality NBFC stocks, with return on equity in the range of 18-20 per cent, are now available at around 1.5 times book value,” he says. He also sees buying opportunities in banking, insurance and two-wheeler spaces as access to loans improves. As investment gathers momentum, he believes capital goods and industrials could also give good returns over the next three years.

S G Raja Sekharan, lecturer on Wealth Management at Christ University, Bengaluru, suggests having a checklist of criteria for evaluating stocks on fundamentals. “Filter stocks on a few fundamentals-based criteria and create a list of limited number of stocks that meet them. Carry out a valuation exercise to arrive at a desirable price for each of these stocks. Then wait for the market correction to make these stocks available at those prices.”

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