The stock markets hit yet another new high on Friday, July 14. A dissection of the top 500 stocks by market capitalisation shows that the participation runs deep across the broader markets and valuations look rich. Here are key takeaways from our analysis and what could lie ahead. Note that this story is based on data as of July 6, which was the earlier high. With the latest close for the Nifty just 0.34 per cent more, the overall numbers and the underlying trend are unlikely to change much.
All-round gains
While the Nifty has gained about 15 per cent from the March 28, 2023, low, the Nifty 500 has outperformed the bellwether comfortably. A dissection of the index constituents shows sharp gains across-the-board, with five stocks even doubling in value (see charts). In all, there were only 28 losers, indicating the broad participation.
As can be expected during any upswing, mid- and small-caps have been all the rage. The Nifty Midcap 150 index has outdone the Nifty by 8 percentage points while the Nifty Smallcap 250 has raced ahead by almost 14 percentage points. Average gains of mid and small-cap stocks part of the Nifty 500, too, stand at 27-28 per cent, higher than that of large-caps.
A look at the trailing valuations puts this trend in perspective. Since the market low on March 28 this year, the Nifty’s trailing 12-month PE (consolidated) has expanded from 20.5 times to almost 24 times now. This is at a premium to long-term averages ( 10-year average of 22.6 times and 20-year average of 20.3 times).
Valuation of the Nifty Midcap100 index, at 26 times, is higher than the Nifty, signalling overheating in this segment. Ditto with small-caps. A dissection of the constituents of the Nifty 500 shows that more stocks trade in the higher valuation bands now than in March (see charts), indicating that valuations are also getting richer across-the-board.
Earnings, the key monitorable
Given that over the long-term stock prices catch up with earnings, what could lie ahead for the markets needs to be seen in the light of the earnings expectation for FY24. As per Bloomberg consensus, earnings per share (EPS) estimates for the Nifty stand at ₹985, a 19.5 per cent growth over ₹824 recorded for FY23. This looks rosy for two reasons. When we last wrote on the market correction in June 2022, Nifty EPS for FY23 was estimated (Bloomberg consensus) at ₹884. The actuals came almost 7 per cent lower. Thus, while a 15 per cent earnings growth was expected for FY23, only about half of it was achieved.
For a perspective, Kotak Institutional Equities, in its recent ‘Strategy’ report released in end-June, estimates Nifty EPS for FY24 at a more conservative ₹910. Hence, investors should take estimates with a pinch of salt. Secondly, though commodities have cooled off, the inflation cool-off cannot still be taken for granted. Food inflation due to changing monsoon behaviour, fuel inflation from crude oil prices stiffening very much remain a possibility in the months to come. The impact of high inflation on domestic demand is also a monitorable. Stickiness in high interest rates can also impact both corporates as well as consumers. For export-oriented sectors, weak global growth expectations is already an overhang.
Playbook for investors
Given that the markets are heated up now and the earnings trajectory is based on many moving parts, investors today can look for stocks a good distance away from all-time highs as well as reasonable valuations. Though the market seems to be at a new high, at least 157 stocks in the Nifty 500 are 25-50 per cent away from their all-time highs and another 87 are even further away.
Stocks with good prospects in this basket can offer higher margin of safety at this point. Many sugar and fertilizer stocks fall in this basket, examples being Triveni Engineering, EID Parry, Coromandel, GSFC, in which bl.portfolio already has ‘buy’/ ‘accumulate’ recommendations. While the focus on government capex has pushed up many infrastructure and capital goods stocks, some such as PNC Infratech, KNR Constructions, HEG, look attractive from a valuation standpoint presently. Some of the stocks that pass this filter from other sectors include KRBL, Amara Raja Batteries, Mahanagar Gas and Sun TV. bl.portfolio already has ‘buy’/’accumulate’ calls on the first three. PSU banks also offer good value at this juncture and clean balance sheets and steady growth prospects buttress the case. For those with a lower risk appetite, the mutual fund route can be safer.
That said, asset allocation also assumes importance at this juncture, and it will be prudent to take some profits off the table, especially if you have overshot your intended allocation to equities. Fortunately, with interest rates close to peak, debt offers good opportunities even without taking higher risk for higher returns.