With Nifty Bank at all-time high, investors need to be wary, say experts

Experts advise that investors better stick to quality names with high predictability on future earnings, to minimise downside risk

Will the Nifty Bank turn pricier than the CNX Nifty soon? That’s the hot topic of debate in the dealing rooms of most brokerages. Trading at 30,427 levels, the valuation of Nifty Bank -- an index that comprises private and public sector banks -- indicates that the banking index is just as expensive as the Nifty, trading at 11,624 points. At current levels, the Nifty Bank and the Nifty, the benchmark index comprising India’s top 50 mega- and large-cap stocks trade at 2.96 times the CY19 estimated book value (see chart), making it the first time for the Nifty Bank index to completely match valuations of the Nifty. Even on the basis of trailing 12-month earnings, the current discount is among the lowest ever.

For investors, this quick jump is harsh to accept given that the Nifty Bank has historically traded at 20–30 per cent discount to the Nifty -- average discount between 2010 and 2018 based on historical earnings is 24.1 per cent. While the discount started waning off about two years back, at the current levels, experts say it’s time expectations from the sector were toned down, even if the rally is supported by fundamentals.

With a gush of foreign money pouring into emerging markets including India, Ajay Bodke, CEO and Chief Portfolio Manager (PMS), Prabhudas Lilladher, explains that large- and mega-cap stocks have gained the most. With this segment largely constituted by frontline banking stocks, it has led to a massive rally of the Nifty Bank. Experts say that the flow of money is also backed by hopes of a stark improvement in earnings. According to Krishnan ASV, banking analysts at SBICAP Securities, as much of delta (or incremental growth) in earnings is expected to be driven by banks, as they come off a low base, it explains for the disproportionate jump in valuations.

Strong hopes of recoveries from bad loans, worst days of elevated provisioning costs behind, and anticipation of interest rate cuts by the Reserve Bank of India (in its policy meeting next week on April 4) which should support profitability are some of the key factors supporting the rally in banking stocks. U R Bhat, director, Dalton Capital Advisors, points out that with other sectors not in a position to replicate growth that the banking sector can offer, the Nifty Bank index may remain expensive in the near- to medium-term.

That said, there is a word of caution, too, for investors. Krishnan warns that banking stocks have little room for error in the coming months. 

“A large part of the current rally in the Nifty Bank is on expectations of normalisation in the sector. But, one or two unanticipated shocks like the IL&FS incident can disrupt the system badly,” he adds.

For investors, this means that even as the fundamentals of the banking sector are being mended, the days of fast and easy money on banking stocks may be well past. “Immediate gains have been accrued already and those taking fresh positions into banking stocks should show patience as repetition of sharp returns as seen in the recent times looks unlikely,” Bodke advices. 

In addition, Krishnan points out that with much of the earnings optimism priced in at current valuations, it leaves little room for sharp rerating in the medium-term. “Even FY21 earnings growth is built into and reflected in the valuations of banking stocks,” he adds.

Therefore, with fast money days unlikely to last longer, banking stocks may be rewarding only for those investors willing to wait patiently. Moreover, the advice from experts is that investors better stick to quality names with high predictability on future earnings, to minimise downside risk.