Indian markets have become overvalued in the absence of earnings growth—a cliché. But how intelligent will it be to paint all companies with the same brush and avoid equity as an asset class altogether?
Undisputedly, there aren’t many low hanging fruits waiting to be plucked anymore—thanks to a vertical rise in equity indices and valuations. But as in the case of individuals, the impact of the pandemic on various companies, their stock market performance and valuations has been quite different.
(Source: NSE)
Despite the present market rally, 296 companies of Nifty 500 trade at a discount to Nifty 50’s 5-year average P/E. And, 340 companies trade at a discount to Nifty’s current PE multiples. Clearly, it’s time to get more stock specific rather than taking cues just from the index movement.
We analyzed Nifty 500 companies taking into account their P/Es, P/Bs and RoEs based on trailing twelve-month earnings. We then compared them with their respective 5-year averages. Are you wondering why so much stress is on trailing twelve months? Because it includes Q1FY21 and the last 3 quarters of FY20, thereby factoring in the lockdown effects on the business.
Going by the management commentaries post Q1FY21 numbers, it seems there’s a consensus among business houses and various industry experts about business prospects. Assuming that we don’t face stringent lockdowns going forward, it would be safe to conclude that Q1FY21 was the toughest and the most unproductive quarter of FY21.
To narrow down further, we focused just on 175 companies that have generated an RoE of at least 15% on TTM earnings and analyzed trends in their earnings and valuations.
On the one hand, companies such as Alembic Pharmaceuticals and Deepak Nitrite have witnessed a compression in their P/E valuations as compared to their respective 5-year averages. This is primarily on account of impressive profit growth they reported over the past few quarters. These stocks have rewarded their investors handsomely.
The likes of Nestle and Britannia haven’t seen much contraction in their PE multiples—denoting that these companies must deliver on expectations to justify expensive valuations.
In contrast, companies such as HDFC Ltd and Just Dial have witnessed their valuations cooling off due dampened stock price performance.
(Source: ACE Equity)
Any company that is quoting above 5-year multiples and has seen stagnation in earnings on the TTM basis. If earnings don’t pick up in the coming quarters, eventually their RoE might take a beating too.
In contrast, companies that offer valuation comfort and have been clocking above-average profits might have tailwinds behind them. If they witness improvement in earnings over the next few quarters, they may have a fair chance of surprising investors pleasantly with their stock price action.
Markets are expensive and the economy is not in great shape but it would be a sweeping assumption that all listed companies will do poorly.
As they say, don’t judge the book by its cover…
You should always investigate why a company trades at lower multiples. Are there any governance related issues, or does the company have bleak growth prospects or does it have a track record of poor capital allocation? Don’t treat any stocks mentioned in this article as a recommendation to buy, hold or sell. This article is merely an attempt to give you a starting point to build your analysis further.
You may also like to read: Do you have any distressed company in your portfolio?
Disclaimer
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
Consult your financial advisor before taking any investment decision.
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.
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