Markets headed for time correction as most of the optimism may be misplaced

• Optimism in the market may be misplaced despite 30% growth in Nifty50’s net profit.
• Near-term momentum in stock prices should not be seen as a guarantee of a company’s long-term prospects.
• Consumer stocks may find it hard to justify rich valuations going forward, claim analysts.
  

Profits of India’s top 50 corporations may have grown by a very healthy clip of 30% in the opening quarter of FY24, but a lot of the optimism around equity markets may be slightly misplaced. India may face fewer headwinds compared to some other developed countries but the domestic economy has its own set of challenges that the markets have been ignoring.

For starters, rural India is not joining the consumption party yet. Be it sales of automobiles or consumer staples, rural India is not splurging on either. The country’s software services exporters are going to see business grow at the slowest pace of 3% or thereabouts for FY24. Performance of bellwether stocks like Infosys and TCS have been less than promising. Infosys has even halved its revenue guidance for the rest of the year.

Yet, Nifty50 is trading at 20.6 times its FY24 earnings per share and at 18 times FY25 earnings. Kotak Institutional Equities is of the view that the valuations show plentiful optimism but no risks. KIE’s analysts expect profitability and returns of most consumption companies to come under sustained pressure over the next few years, which will likely weigh on their rich multiples. Last, there is hardly any margin of safety to absorb any potential negative events.

Kotak’s analysts have busted the Q1 performance by analysing the 30% year on year growth in EBITDA of Nifty companies. Adjusting for other income by some of the larger companies, Kotak says that higher than assumed operating income was driven by other income and large beat in the case of just one company (JSTL).

Given the sharp run up in stocks (Nifty50 up 6% in three months), the upside looks limited as strategists believe that a period of consolidation will continue for a longer period of time. The positives are hard to ignore and they do include potential recovery in profits and volumes through the rest of the year, stable macroeconomic conditions in India and stable interest rates globally. But the only downside that Kotak Institutional Equities has found is lack of any wiggle room in valuations in case a negative event hits Indian markets.

But it is not just Kotak’s strategists that have a problem with expensive stocks. ICICI Securities also recommends staying away from expensive domestic cyclicals where current valuations are extrapolated to reflect long-term prospects of the company. The brokerage says that given the high demand for sustainable growth stocks, expensive domestic stocks at times tend to factor in a lot of euphoria. A bulk of the current market value is attributed to long- term prospects, which can often run into speculative territory. The brokerage prefers stocks with attractive long-term prospects and avoids speculating too much on long-term prospects.

Currently, most of the stocks that are seeing earnings upgrades and better stock performance are in the bucket which is betting big on investment revival and not a consumption revival. In fact, many brokerages believe that expensive valuations of most consumer companies are misplaced and that most consumer companies will not be able to deliver the kind of growth momentum reflected in valuations.