By Deeksha Janiani
The Indian stock markets have been a big draw for investors in June, as the benchmark indices surged to new highs. The Nifty 50 index has bounced back sharply from its March lows, gaining 10.2% in the following months. The market revival has been boosted by accelerated foreign investments.
Let’s rewind to March 2023, when the market sentiment was gloomy, and global and midsize American banks - Credit Suisse, Silicon Valley Bank, First Republic - were collapsing like a house of cards. Investors were filled with apprehension, anticipating shockwaves on the Indian economy. However, foreign investors saw an opportunity to move to the Indian market, which looked relatively stable and where valuations had become attractive.
India’s economy has also proved its resilience since then – inflation has cooled off, credit growth remains strong, services activity has touched new highs, public capex has progressed well, and Q4 GDP growth has beaten estimates. Even India Inc didn’t disappoint, with Nifty 50 companies clocking over 12% sequential and YoY earnings growth in Q4FY23.
Now, as we take on the risky but time-honored exercise of trying to figure out the future of the markets, two pressing questions arise: has the recent rally exhausted its momentum? Have the markets entered the overvalued zone?
India was among the top emerging markets in May, but has turned pricey
As interest rates rose, analysts were cautioning investors about putting money into Indian equities at the start of 2023. “We believe India’s growth cycle has peaked and is headed significantly lower”, Nomura said in early March. But markets made a U-turn in April.
The Nifty 500 index gained nearly 3% in May, comfortably surpassing some of its Asian peers, including China. While China’s market rally, driven by the reopening story, fizzled out quickly due to weak economic data, India saw a more favorable economic landscape.
China saw a decline in exports in May, weak home sales, ongoing contraction in manufacturing activity, and a high youth unemployment rate of 20.4%. Reports suggest that the Chinese youth are thronging temples seeking divine intervention, while lottery ticket sales also rose to a decadal high in April.
India, on the other hand, looks more resilient. But it's also the most expensive among emerging market indices when looking at the trailing PE metric. This premium valuation can be justified by the robust performance of the Indian economy and the positive earnings outlook for Indian companies.
Indian indices usually trade at a premium compared to other emerging markets. For instance, MSCI India index has historically commanded a 70% premium over the MSCI Emerging Markets index. However, it scaled that level and its valuation was nearly double of the EM index in May end. MSCI India has gained another 1.5% in June so far.
Foreign brokerages are optimistic about Indian markets despite stretched valuations
Commenting on the strides that India has made, a Morgan Stanley report said, “This India is different from the one in 2013. In a short span, India has gained positions in the world order with positive consequences for the macro and market outlook.”
Although Morgan Stanley finds the Indian market a bit expensive, it believes in the underlying economic story. It expects manufacturing and capex to steadily rise as a share of GDP, with per-capita incomes more than doubling by 2032. These factors make Indian equities a compelling investment.
Goldman Sachs also remains bullish on Indian markets, given the alpha opportunities that they present. According to Goldman, 54% of the Nifty 500 universe has generated 10-bagger returns over a 5-year rolling period in the past two decades. This is the highest proportion of multibaggers among the 10 emerging markets it analyzed.
Chris Wood, the global head of equities at Jefferies, expresses his optimism about the BSE Sensex, saying, “I would be disappointed if the Sensex does not touch 100,000, five years from now. Valuations are not super cheap but they are certainly not crazily expensive.” This target translates to compounded annual returns of 10%.
While foreign brokers are largely positive on the Indian market, they do have sector preferences. These sectors include banking, capital goods, real estate and infrastructure, which have posted robust earnings growth in the past quarter.
Domestic brokerages differ on their view of India market valuations
The Nifty 50 had an average one-year forward PE ratio of 18.5X as of May end. On comparing it with the 10-year averages, Motilal Oswal and Prabhudas Lilladher found that it was trading at an average discount of 10%. This discount has narrowed post the gains in June.
However, taking a much longer time frame of 18 years, ICICI Securities and Axis Securities discovered that the benchmark had become relatively pricey. So, it's really a question of how one compares it.
Let’s consider another valuation tool popularized by Warren Buffet. According to a Motilal Oswal report, India’s market cap to GDP (FY23) ratio stands at 95%. This is significantly higher than that of EMs like China, Brazil and Indonesia, as well as India’s own long-term average of 81%.
Considering various metrics and comparisons, it is evident that our markets are pricier now. But foreign and domestic brokers predict the Nifty reaching an average price of 20,200 by March 2024, indicating an upside of just around 8% from current levels.
While the Indian Indices are fully priced, there may still be some valuation gaps within the underlying sectors.
Banking, auto and real estate stocks offer interesting buying opportunities
Several sectors like retail, auto, healthcare and private banks are trading at a discount compared to their historic valuations. In contrast, sectors like consumer goods, specialty chemicals, real estate and technology are commanding a premium.
Financials and auto seem appealing considering their growth prospects. Within the financial sector, top banks like HDFC Bank, Axis and Kotak Mahindra are relatively cheaper now. The timing is also favourable for the banking industry, with credit growth set to sustain its double-digit pace in FY24.
The auto space is at a discount of roughly 20% to its long-term average PE. Heavyweights like Maruti Suzuki and Eicher Motors may clock earnings growth of 25%+ in FY24, according to Trendlyne’s Forecaster. And yet they are in the undervalued zone. Maruti’s stock also looks attractive if we compare its forward PE to the expected EPS growth.
There are some valuation gaps within the real estate space as well. Companies like DLF and Godrej Properties are quoting 12M forward PE discounts of over 40%, compared to their historical averages. Nifty Realty is yet to reach its peak from November 2021. But with RBI pausing the rate hikes and demand being healthy, it has the potential to reach new heights.
The healthcare sector, particularly pharma stocks, may experience a revival in growth in FY24 due to lower costs and a recovery in the US market. Regulatory issues and intense competition in the US generics market have put pressure on their valuations.
All in all, the current market conditions present a great chance for investors to be selective in their equity investments. Picking sectors and companies that align with India's consumption and capital expenditure (capex) narrative can lead to higher future gains.
This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.