“Limited opportunities” to make money in Indian equity markets due to rich valuations – Kotak Sec

Opportunities for making money in the current equity markets in India are ‘limited’ given expensive valuations across sectors and potential risks of earnings-downgrades, Kotak Securities’ Private Client Group warned in its monthly update.

“The future for the markets may not all be all rosy with headwinds arising also from international shores with the U.S. Fed indicating two successive rate hikes and the war in Ukraine still ongoing,” it noted.

“Against this backdrop, we believe that investors should look to boost the resilience of equity portfolios by focusing on a combination of high-quality names, strong dividend payers and regional diversification,” it said.

The brokerage house noted that though the near-term outlook for India remains constructive backed by steady economic recovery and festive season demand, valuations leave little room for upside. It advised investors to tread with caution and emphasized adding quality stocks gradually on market declines.

Rich Valuations

Kotak Securities highlighted that the benchmark Nifty trades at 19.4 times estimated earnings for FY2024 and 16.9 times for FY2025, leaving limited upside potential from current levels. The Nifty remains up nearly 8% year-to-date despite global headwinds and marginally off its all-time highs.

According to the brokerage, the optimism driving India’s expensive valuations stems from a revival in corporate earnings after the pandemic shock. It expects Nifty earnings to clock double-digit growth of 15.8% in FY2024 and 13% in FY2025 after an 11.1% expansion in FY2023.

However, Kotak pointed out that current valuations seem to factor in only the positives of earnings recovery seen so far and do not account for any downside risks both globally as well as domestically.

“First-quarter results showed persistent weakness in consumption demand and an expected slowdown in IT services demand..” it pointed out.

Kotak Securities believes that earnings upgrades may hit a roadblock on account of increasingly challenging global environment with recession looming in the US and Europe, and domestic vulnerabilities like stretchy valuations, persistent inflation, uneven monsoons, and moderate GDP growth forecasts. Margin pressures may also build up due to elevated input costs and higher interest rates.

The Private Client Group arm of Kotak Securities said it remains optimistic on India’s economic and corporate earnings recovery over the medium to long term, but suggested deploying caution in the near term while investing in equities at current levels.

Portfolio Diversification

It advised equity investors to balance quality and valuation prudently in the prevailing environment and accumulate resilient companies with strong earnings visibility, healthy balance sheets, and reasonable valuations on market declines.

The brokerage house emphasized looking at opportunities beyond the largecaps to broaden portfolio resilience. It remains positive on select opportunities in banking, autos, capital goods, and consumption sectors.

Within banking, well-capitalized large private sector lenders like HDFC Bank, ICICI Bank, and SBI appear attractive plays given their retail franchise, growth recovery, stable asset quality and reasonable valuations. Their investments in digital channels, focus on secured retail lending, and granular loan books make them future ready, as per Kotak.

In autos, passenger vehicle makers Maruti, M&M, and Ashok Leyland warrant attention owing to demand uptick, new launches, and ability to take price hikes to defend margins. Their call is also predicated on improved capital allocation discipline and cost optimization actions taken by auto companies during the downturn.

Capital goods and engineering majors like L&T, Siemens, ABB India, and Thermax could benefit from the government’s infrastructure mega-plans, manufacturing incentives like PLI scheme, and China+1 advantage arising from geopolitical realignments. Order book traction, revenue growth momentum, and margin drivers make this space an attractive cyclical bet.

Lastly, Kotak remains sanguine on defensive consumption stocks like HUL, Britannia, Asian Paints, and Pidilite despite their premium valuations owing to their brand strength, pricing power, distribution reach, and innovation prowess enabling consistent sales and earnings growth across business cycles.