Bottomline: Market’s got little value headroom

With the Nifty (NSE-50 index of stocks) near 18,000 and the Sensex (BSE index of 30 stocks) near 60,000, stock valuations aren’t cheap. Even as the world grapples with uncertainties, Indian equities are riding the safe-haven wave to push higher. With growth being a rarity in a geopolitically disrupted world and some central banks, like the US Federal Reserve, determined to slow their economies down, India stands out as a beacon of growth.

While this is good news for domestic investors, who’ve been spared a pummeling of their portfolio values, it doesn’t make stocks cheap from a historical valuation perspective. As in the uncertain Covid period, when analysts chose to look beyond earnings at the book value of companies to get a grip on value, we’ve done the same today, even as analysts roll over their targets to their uncertain fiscal 2024 earnings estimates. And what we found was not comforting, mostly.

The BSE-Sensex price-to-book value (P/BV) today stands at 3.3x, that’s in line with the average multiple in the past 25 years. And while the Sensex did see a high of 5.5x in 2008 and a low of 2.2x in 2003, those are not the normal ranges you should be working with. Over the past 10 years, the Sensex P/BV multiple has ranged between 2.8x and 3.5x. And this offers an upside potential of just about 6 percent. So, there’s limited headroom on the upside from current levels on a sustainable basis.

A look at the BSE-500 P/BV ratio trend reveals a similar picture. The index today trades at a multiple of 3.2x compared to an 18-year average of 3x. And this is up sharply from 2.6x in 2020. So, the midcaps aren’t necessarily cheap either. Both the above indications, advise caution for investors, especially when it comes to making fresh investments when the indices are nearing their recent highs.

Banks and financials have been the big bets of most savvy investors in the recent past and their conviction has been vindicated by the excellent performance of most frontline lenders in the recent quarterly earnings reports. But banks, after their recent run-up, aren’t that cheap. The BSE-Bankex P/BV ratio is today at 2.3x versus an 18-year average of 2.2x. Auto stocks after the recent rally have caught up with historical valuations, after a period of significant underpricing. The BSE-Auto index today commands a P/BV of 4.1 compared to an 18-year average of 4x, far above the 2.6x it plummeted to in 2020. Even realty stocks are trading at near 3x, compared to their 15-year average of 2.1x. In this case though, given the long cycle nature of the business, it also helps to compare the previous boom period of 2010 to 2013, during which the multiples ranged between 4-5x. Seen in this context, some might argue there’s still headroom for gains.

Another sector that’s been in the limelight is IT services. With frequent buybacks, P/BV becomes a less relevant measure of valuation. But if you look at dividend yield, it suggests that valuations are almost near historical levels now. The current dividend yield of 1.9 percent is just a tad higher than the 8-year average of 1.8 percent—up sharply from 1.4 percent last year.

Now let’s look at a few pockets where there’s still value, based on historical trends. Public Sector Enterprises is clearly one such pocket. The current P/BV of 1.1x is well under the 18-year average of 1.8x. The BSE Capital Goods index also trades at 3.9x compared to its 18-year average of 4.7x. A little lesser under valuation is seen in energy with the multiple of the BSE Energy index at 1.75 versus an 8-year average of 1.9x.

Given how valuations are today, it would be prudent for investors to wait before putting money to work in the market. And if they really must invest now, short-term opportunities may be available in select stocks in pockets like PSUs, capital goods and energy.

Happy investing!