HDFC Securities: The Indian stock market has been on a stellar run in the past year, with the Nifty 50 index hitting new all-time highs and crossing the 15,000 mark for the first time in February 2024. The Nifty midcap and smallcap indices have also outperformed the benchmark index, delivering returns of over 55% and 75%, respectively, in the same period. However, this rally has also led to a sharp increase in the valuation of the market, raising concerns about its sustainability and future prospects.
HDFC Securities
According to a recent report by HDFC Securities, the Nifty 50, Nifty Midcap 100, and Nifty Small-Cap 100 indices seem to be overvalued at the aggregate level, based on various valuation metrics such as price-to-earnings (PE), price-to-book (PB), dividend yield (DY), and market capitalization-to-GDP (MCAP/GDP) ratios. The report also suggests that further expansion of multiples is unlikely, given the high expectations of earnings growth and the possibility of rising interest rates and inflation.
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The report advocates a bottom-up stock picking approach for investors rather than a top-down sectoral or thematic one, as the valuation dispersion within the indices is high and there are pockets of value and growth opportunities across sectors. The report also provides a sector-wise analysis of the Nifty 50 index, highlighting the relative valuation and performance of each sector, as well as the key drivers and risks.
Nifty 50 valuation and performance
The Nifty 50 index, which represents the 50 largest and most liquid companies in the Indian market, has gained 32% in the past year, outperforming the MSCI Emerging Markets index by 18%. The index has also surpassed its pre-COVID peak of 12,430 in January 2020 and reached a new high of 15,431 in February 2024.
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However, this rally has also pushed the valuation of the index to elevated levels, as seen in the table below. The Nifty 50 index is trading at a PE ratio of 28.6, which is higher than its long-term average of 19.4 and its historical peak of 28.3 in December 2007. The index is also trading at a PB ratio of 4.1, which is above its long-term average of 3.4 and its historical peak of 4.6 in January 2008. The index has a DY of 1.1%, which is lower than its long-term average of 1.5% and its historical low of 0.9% in December 2017.
The index has a MCAP/GDP ratio of 110%, which is higher than its long-term average of 75% and its historical peak of 103% in January 2008.
| Valuation Metric | Nifty 50 | Long-Term Average | Historical Peak | Historical Trough |
|---|---|---|---|---|
| PE Ratio | 28.6 | 19.4 | 28.3 (Dec 2007) | 10.9 (Mar 2009) |
| PB Ratio | 4.1 | 3.4 | 4.6 (Jan 2008) | 2.2 (Mar 2009) |
| Dividend Yield | 1.1% | 1.5% | 2.9% (Mar 2009) | 0.9% (Dec 2017) |
| MCAP/GDP | 110% | 75% | 103% (Jan 2008) | 43% (Mar 2009) |
Source: HDFC Securities, NSE, World Bank
The high valuation of the Nifty 50 index reflects the strong recovery of the Indian economy and corporate earnings from the COVID-19 pandemic, as well as the positive sentiment driven by the vaccine rollout, fiscal stimulus, monetary easing, foreign inflows, and domestic liquidity. However, the report cautions that the valuation premium of the index may not sustain itself in the medium to long term, as earnings growth expectations are already high and the macroeconomic conditions may become less favorable.
The report estimates that the Nifty 50 index will deliver a compounded annual growth rate (CAGR) of 12–13% in earnings per share (EPS) between FY24 and FY26, which is higher than the historical average of 10%. However, this implies a PE ratio of 22.6 by FY26, which is still above the long-term average of 19.4. The report also expects interest rates and inflation to rise gradually in the next two years as economic activity normalizes and policy support is withdrawn. This may increase the cost of capital and reduce the attractiveness of equities relative to fixed income.
The report suggests that investors should adopt a bottom-up stock picking strategy rather than a passive index investing approach, as there are significant valuation differences within the Nifty 50 index and across sectors. The report identifies banks and staples as the relatively less expensive sectors, while IT and consumer discretionary are the most expensive sectors. The report also provides a detailed analysis of each sector, highlighting the key drivers, risks, and outlook.
Sector-wise analysis of the Nifty 50 index
The Nifty 50 index comprises 12 sectors, namely financial services, energy, IT, consumer goods, automobiles, metals, pharma, telecom, construction, media, cement, and utilities. The table below shows the weightage, performance, and valuation of each sector in the index as of February 2024.
| Sector | Weightage | 1-Year Return | PE Ratio | PB Ratio | Dividend Yield |
|---|---|---|---|---|---|
| Financial Services | 35.6% | 28.7% | 23.4 | 2.8 | 1.3% |
| Energy | 13.4% | 17.2% | 18.9 | 2.6 | 2.8% |
| IT | 12.9% | 51.4% | 35.6 | 8.1 | 1.4% |
| Consumer Goods | 11.9% | 16.8% | 48.7 | 14.2 | 0.9% |
| Automobile | 7.3% | 36.5% | 38.2 | 5.9 | 0.9% |
| Metals | 5.2% | 97.2% | 14.8 | 2.3 | 1.9% |
| Pharma | 4.2% | 39.4% | 37.9 | 6.4 | 0.7% |
| Telecom | 3.6% | 18.4% | 23.1 | 3.1 | 0.4% |
| Construction | 2.8% | 54.6% | 31.4 | 4.1 | 0.6% |
| Media | 1.2% | 34.2% | 25.6 | 3.9 | 1.2% |
| Cement | 0.8% | 40.3% | 32.1 | 4.5 | 0.8% |
| Utilities | 0.8% | 8.9% | 15.2 | 1.3 | 3.2% |
Source: HDFC Securities, NSE
The report provides a brief overview of each sector, as follows:
Financial Services
The financial services sector is the largest and most influential sector in the Nifty 50 index, with a weightage of 35.6%. The sector consists of banks, non-banking financial companies (NBFCs), insurance companies, and asset management companies (AMCs). The sector has performed well in the past year, gaining 28.7%, as asset quality and credit growth improved after the COVID-19 shock. The sector is also expected to benefit from the economic recovery, lower interest rates, higher credit penetration, and digital transformation.
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The sector is trading at a PE ratio of 23.4 and a PB ratio of 2.8, which are lower than the index averages of 28.6 and 4.1, respectively. The sector also has a higher DY of 1.3%, compared to the index average of 1.1%. The report considers the sector relatively less aggressive and active, given its growth potential and valuation comfort. The report also prefers private sector banks over public sector banks, as they have better asset quality, capital adequacy, profitability, and governance.
The key drivers for the sector are the revival of credit demand, the resolution of stressed assets, the growth of retail and digital segments, the consolidation and market share gains, the regulatory support and reforms, and the innovation and diversification of products and services.
Energy
The energy sector is the second-largest sector in the Nifty 50 index, with a weightage of 13.4%. The sector consists of oil and gas exploration and production companies, refining and marketing companies, and gas distribution companies. The sector has performed moderately in the past year, gaining 17.2% as oil and gas prices recovered from the COVID-19 slump. The sector is also expected to benefit from rising domestic and global energy demand, the diversification of energy sources, and government policies and reforms.
The sector is trading at a PE ratio of 18.9 and a PB ratio of 2.6, which are lower than the index averages of 28.6 and 4.1, respectively. The sector also has a higher DY of 2.8%, compared to the index average of 1.1%. The report considers the sector relatively less expensive and attractive, given its stable cash flows and dividend payouts. The report also prefers integrated oil and gas companies over standalone refining and marketing companies, as they have better margin stability and growth prospects.
The key drivers for the sector are the recovery of oil and gas prices, the increase in domestic production and consumption, the expansion of gas infrastructure and distribution, the adoption of cleaner and renewable energy sources, and regulatory support and reforms. The key risks for the sector are the volatility of oil and gas prices, environmental and social concerns, geopolitical tensions and conflicts, and competition from alternative energy sources.
IT
The IT sector is the third-largest sector in the Nifty 50 index, with a weightage of 12.9%. The sector consists of software services and product companies catering to various industries and geographies. The sector has performed exceptionally well in the past year, gaining 51.4%, as the COVID-19 pandemic accelerated the digital transformation and adoption of cloud, data, and automation solutions. The sector is also expected to benefit from the increasing demand for digital services, the resilience and adaptability of the business models, and the strong deal pipeline and execution.
The sector is trading at a PE ratio of 35.6 and a PB ratio of 8.1, which are higher than the index averages of 28.6 and 4.1, respectively. The sector also has a lower DY of 1.4%, compared to the index average of 1.1%. The report considers the sector to be relatively more expensive and overvalued, given its high valuation multiples and limited upside potential. The report also prefers large-cap IT companies over mid-cap and small-cap IT companies, as they have better scale, diversification, profitability, and governance.
The key drivers for the sector are the growth of digital services, the recovery of core services, the increase in outsourcing and offshoring, the improvement in client spending and sentiment, and the innovation and differentiation of products and services. The key risks for the sector are the rise in competition and pricing pressure, the shortage of talent and skill gaps, the regulatory and legal challenges, and the currency fluctuations and hedging costs.
Consumer Goods
The consumer goods sector is the fourth-largest sector in the Nifty 50 index, with a weightage of 11.9%. The sector consists of fast-moving consumer goods (FMCG) companies, which produce and sell essential and discretionary products such as food, beverages, personal care, household care, etc. The sector has performed moderately in the past year, gaining 16.8%, as the COVID-19 pandemic impacted the demand and supply of consumer goods. The sector is also expected to benefit from the recovery of rural and urban consumption, the increase in disposable income and penetration, and the innovation and premiumization of products and services.
The sector is trading at a PE ratio of 48.7 and a PB ratio of 14.2, which are higher than the index averages of 28.6 and 4.1, respectively. The sector also has a lower DY of 0.9%, compared to the index average of 1.1%. The report considers the sector to be relatively more expensive and overvalued, given its high valuation multiples and limited upside potential. The report also prefers staples over discretionary, as they have better demand resilience and margin stability.
The key drivers for the sector are the revival of consumer demand, the improvement of distribution and logistics, the growth of e-commerce and modern trade, the expansion of rural and urban markets, and the innovation and differentiation of products and services. The key risks for the sector are the rise in raw material and input costs, the increase in competition and price wars, regulatory and tax changes, and consumer behavior and preference shifts.
Automobile
The automobile sector is the fifth-largest sector in the Nifty 50 index, with a weightage of 7.3%. The sector consists of automobile manufacturers and ancillaries, which produce and sell various types of vehicles, such as passenger cars, commercial vehicles, two-wheelers, three-wheelers, etc. The sector has performed well in the past year, gaining 36.5%, as the COVID-19 pandemic boosted the demand for personal mobility and low-cost vehicles. The sector is also expected to benefit from the recovery of economic activity and infrastructure, the increase in disposable income and affordability, and the adoption of electric and hybrid vehicles.
The sector is trading at a PE ratio of 38.2 and a PB ratio of 5.9, which are higher than the index averages of 28.6 and 4.1, respectively. The sector also has a lower DY of 0.9%, compared to the index average of 1.1%. The report considers the sector to be relatively more expensive and overvalued, given its high valuation multiples and limited upside potential. The report also prefers two-wheelers over four-wheelers, as they have better demand elasticity and growth prospects.
The key drivers for the sector are the recovery of vehicle demand, the improvement of supply chain and production, the growth of exports and aftermarket, the expansion of financing and leasing options, and the innovation and diversification of products and services. The key risks for the sector are the rise in fuel and input costs, the increase in competition and price pressure, regulatory and environmental changes, and technological disruption and transition.
What are some examples of undervalued stocks in the Nifty 50?
Undervalued stocks are those that trade below their intrinsic value, which is the present value of their future cash flows. There are various methods and metrics to estimate the intrinsic value of a stock, such as discounted cash flow (DCF), dividend discount model (DDM), residual income model (RIM), etc. However, these methods are based on assumptions and estimates, which may vary from analyst to analyst and from time to time. Therefore, there is no definitive list of undervalued stocks, but rather different opinions and perspectives.
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One way to identify undervalued stocks is to compare their valuation multiples, such as price-to-earnings (P/E), price-to-book (P/B), dividend yield (DY), etc., with their historical averages, industry averages, or index averages. Stocks that have lower valuation multiples than their peers or benchmarks may be considered undervalued, as they indicate that the market is underestimating their earnings potential, growth prospects, or dividend payouts.
Based on this approach, some examples of undervalued stocks in the Nifty 50 as of February 2024 are:
Oil and Natural Gas Corporation (ONGC), which is the largest oil and gas exploration and production company in India, has a market share of 75%. It is trading at a P/E ratio of 6.07, which is lower than its long-term average of 10.5 and its historical low of 5.5 in March 20202. It is also trading at a P/B ratio of 0.78, which is lower than its long-term average of 1.2 and its historical low of 0.7 in March 20202. It has a DY of 6.19%, which is higher than its long-term average of 4.5% and its historical high of 5.9% in March 20202.
Coal India Ltd. (CIL), which is the largest coal producer and supplier in India, has a market share of 80%. It is trading at a P/E ratio of 6.5, which is lower than its long-term average of 11.5 and its historical low of 6.1 in March 2020. It is also trading at a P/B ratio of 2.97, which is lower than its long-term average of 4.2 and its historical low of 2.8 in March 2020. It has a DY of 8.43%, which is higher than its long-term average of 6.5% and its historical high of 8.1% in March 2020.
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Tata Steel Ltd. (TSL), which is the largest steel producer and exporter in India, has a market share of 25%. It is trading at a P/E ratio of 92.9, which is higher than its long-term average of 15.5 and its historical high of 88.5 in December 2020. However, this is mainly due to the low earnings base in FY20 and FY21, which were affected by the COVID-19 pandemic and the global steel downturn. The company is expected to report a strong earnings recovery in FY22 and FY23, driven by the improvement in steel prices, demand, and margins.
The company is also trading at a P/B ratio of 1.09, which is lower than its long-term average of 1.5 and its historical low of 0.9 in March 2020. It has a DY of 2.91%, which is higher than its long-term average of 1.5% and its historical high of 2.8% in March 2020.
These are just some examples of undervalued stocks in the Nifty 50, based on one approach and one source of data. Investors should do their own research and analysis before investing in any stock, as there may be other factors and risks that affect its value and performance.
