Nifty, Sensex now at 'reasonable valuations' but midcaps, small caps and financials still have some juice left

• Indian equity markets are now trading at “reasonable valuations” after having outperformed their global peers in 2022.
  
• While Nifty50 significantly outperformed Dow Jones and S&P 500 in 2022, among other indices, it is flat so far in 2023.
  
• Midcap, smallcap and financial stocks still have juice left, according to analysts, thanks to their lower PE multiples compared to ‘growth’ and largecap stocks.
  

After outperforming their global peers in 2022, valuations of Indian equity markets have now corrected to reasonable levels. The 12-month forward price-to-earnings ratio of the benchmark Nifty50 index is now below the 10-year average, in line with global peers.

Concerns of a global economic slowdown have weighed on investor sentiments this year. Nifty50, which outperformed Dow Jones and S&P 500 significantly in the last one year, is flat in 2023 so far. For context, Nifty50 has risen nearly 14% in the last one year, while Dow Jones has gained 2% and S&P 500 3.4%.

This has brought back Nifty50’s valuations into ‘reasonable’ territory, say analysts. Nifty50’s current PE ratio is at 21.24, lower than its long-term average (10 years) of 24.24.

PE ratio is a popular metric to measure valuations.

“The Indian market is trading at reasonable valuations compared with recent history and bond yields,” said the analysts at Kotak Institutional Equities.


Source: MSCI, Dow Jones, Birinyi Associates, Prime Investor

However, even though Nifty50’s current PE is lower than its 10-year average, analysts say there is still not enough room for investors to pump in money aggressively into Indian equity markets.

“Most ‘growth’ stocks, especially in the consumption, investment, and outsourcing space, are trading at expensive valuations, despite increasing near-term demand issues and medium-term risks of disruption,” the Kotak report added.

On the other hand, the Nifty Midcap 150 and Smallcap 250 indices are trading well below their 5-year PE. While Midcap 150 is trading at a PE of 26.2, Smallcap 250 is trading at a PE of 20.05. Their 5-year average PE stands at 34.7 and 33.36, respectively.

Apart from mid and smallcap stocks, analysts at Kotak believe that the financial sector still has some juice left. “Financials remain reasonably valued and appear attractive in the context of a likely healthy credit cycle over the next 1-2 years,” the Kotak report said.

Big boys drive Nifty50’s growth

Nifty50’s revenue and profit growth in FY23 has been driven largely by the big boys – the top performers in terms of absolute revenue and profit remained giants like Reliance Industries, State Bank of India, HDFC Bank, ICICI Bank and auto companies.

FY23 also witnessed 11 companies in the Nifty50 companies reporting a decline in their annual profit. So far, 44 out of 50 companies in the index have declared their FY23 results.

In such a scenario, it is essential for investors to look at the earnings growth outlook for the next two years instead of focusing on just the 10-year Nifty50 PE and comparing it with the current PE.

“Factors like earnings growth forecasts for the next two years, interest rates and their trend and other qualitative triggers also need to be considered before getting excited to become large buyers,” said Deepak Jasani, head of retail research, HDFC Securities.

The risk of El Niño, global economic slowdown concerns and future growth outlook could keep investors and markets on their toes.

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