Search for 'value' gets tougher for market investors

High valuation making it difficult to identify new opportunities, say experts

The market has moved up significantly in the past year, with the benchmark BSE Sensex gaining 16 per cent. The rally has largely been driven by global liquidity and on expectations that earnings back home will pick up in the coming quarters. At a one-year trailing price-to-earnings multiple (P/E) of 22.8, the Sensex is still trading above its historical average.

It's a difficult terrain for value investors. Should they use the intermittent corrections as buying opportunities or stay on the sidelines?

"We are seeing a situation where the pace in growth in earnings has been quite subdued, whereas the growth in stock prices has been brisk. In this scenario, high valuation multiples have made it difficult to identify new opportunities," said Rajeev Thakkar, director, PPFAS.

For stock selection, apart from P/E and price-to-book value (PB), value investors typically look at parameters such as discount to intrinsic value, dividend yield and discounted cash flows.

"As a value investor, the aim is to get good, risk-adjusted, long-term returns. Investors can put money in companies after assuming a certain rate of earnings growth but there is a high likelihood of getting one's assumption wrong in an elevated multiples market," says Mrinal Singh, deputy chief investment officer-equity, ICICI Prudential AMC.

However, pockets of 'value' can still be found. "Attractive values are often accompanied by uncertainties and headwinds. Given that sectors like information technology (IT), pharmaceuticals, banking and telecom have gone through tough times, there are many seeking values in these spaces," said Thakkar.

While the mid-cap and small-cap universe is believed to be much more expensive than the large-cap basket, the chance of finding value in the former is theoretically higher. This is because there are 4,000-5,000 such stocks which are far less researched than large-caps. "Investors need to dig deeper and go beyond the stocks included in benchmark indices such as a Nifty Free Float Midcap 100 index to find value," said Singh.

According to a recent report by Credit Suisse, a market-cap weighted portfolio of high P/E stocks in the BSE 500 outperformed the portfolio of low P/E stocks by 41 per cent between January 2011 and May 2016. Since June 2016, however, the trend has reversed, with low P/E outperforming high P/E stocks by 23 per cent.

The low and high P/E buckets were created depending on whether their forward P/E was lower or higher than the median.

Illustration: Ajay Mohanty\

Value traps

A typical trap is to indiscriminately buy companies trading at 52-week or multi-year lows. Another is to sell high quality companies which look expensive and invest in companies run by questionable promoters only because they are cheap.

Investors need to be cautious about selecting names in sectors which are excessively leveraged or with high competitive intensity. "Low valuations may be justified in some cases. Ensure that the current troubles faced by the company/sector are temporary, not enduring," said Thakkar.

Themes/sectors to look at

Agri and rural: Agriculture will see traction on the back of government push. Companies in agri equipment and agro chemicals should see traction on the back of a normal monsoon forecast. Crop insurance and the push for Direct Benefits Transfer (DBT) should lead to demand for farm inputs and benefit entities in the organised sector. The waiving of farmer loan in certain states will improve purchasing power and aid pick-up in rural demand.

Pharma: Several pharmaceutical majors missed their earlier forecasts by a wide margin in the March quarter. However, the pain might be temporary. "Once Indian pharma companies come up the curve in terms of regulatory compliance, their progress in more lucrative spaces such as complex generics and speciality drugs will be unencumbered, and the sector multiple is likely to re-rate," says a note by HDFC Securities.

Movement due to GST: Most buildings material segments such as tiles, sanitaryware, PVC pipes, electrical cables and fans have a 30-50 per cent unorganised end-market. "With implementation of the goods and services tax (GST), the tax arbitrage on which unorganised markets were thriving will reduce substantially, benefiting the existing listed players," says Ravi Gopalakrishnan, head of equities at Canara Robeco Asset Management.

Telecom: Further consolidation is likely, with smaller companies getting acquired. "Those which cannot meet the bank liabilities will go out of the system; those which can ride out the tough times can emerge winners in the long run," says Thakkar.

Information technology: IT is going through a transitory phase, with companies increasing investments in automation, machine learning, design thinking and artificial intelligence. "Those who can adapt to the new business model quickly stand to gain," says Thakkar.

Affordable housing push: Housing finance companies will benefit as demand, driven by government push to affordable housing, comes into play over the next two to three years, says Gopalakrishnan.

Power: The government has increased its focus on power connectivity, which will help this neglected sector to start performing.