Mumbai: For diehard value stock pickers, companies with rich share valuations are a strict no entry zone. With the record-breaking equities rally catapulting valuations of several shares to lofty levels, many of such investors would have found themselves being spectators as a chunk of the stock outperformers in recent months have been the pricier one.
In theory, when the price-to-earnings (PE) ratio – a popular valuation measure – of a stock or an index is above averages, the stock is considered richly valued and is considered to have limited upsides.
On the contrary, 48% of stocks on the NSE 500 with PE ratios above 50 at 2022 end have surpassed market performance in the current year.
Analysts said most of the companies with elevated PE ratios are the ones that exceeded investor expectations in revenue and earnings.
As of December 30, 2022, 131 stocks on NSE 500 were trading at PE ratios of above 50. Out of them, 63 returned more than 23% so far this year.
For instance, Trent, a Tata Group-owned retailer and hypermarket chain, has delivered a return of 121% in 2023, even with a PE ratio of 128 at the end of the previous year. The company has reported sales and profit growth of 53% and 101%, respectively, in the trailing 12 months ending September 2034 compared to a similar period the previous year.
KPIT Technologies, with a PE ratio of 61 times as of December 30, 2022, has seen a rally of 115%. It reported 56% growth in revenue and 54% growth in net profit for the trailing 12 months ended September 2023. Similarly, ABB, with a PE ratio exceeding 91, surged 80% in 2023.
“Anticipations of improved earnings are translating into higher stock prices, resulting in increasingly elevated PE ratios and hence, a discernible overbought sentiment is emerging, as reflected in various technical parameters,” said Anand James, chief market strategist at Geojit Financial Services. “Nevertheless, recent developments, such as the latest consumer price index, the Federal Reserve’s dovish statements, serve to validate the potential for increased involvement of overseas investors and heightened demand for high-quality stocks, despite their escalating prices.”
Analysts state that the outperformance of quality stocks is expected to persist despite elevated valuations.
The recent stock market surge has propelled the PE ratio of 174 stocks from the Nifty 500 universe to over 50 times. The PE ratio of the NSE 500 is at 25 times and that of the Nifty 50 is at 23 times.
“Investors should focus on those stocks with high growth in revenues and profits which are likely to continue strong momentum,” said James.
Investors have discarded shares of companies with high valuations whose earnings have been under pressure. As many as 18 stocks, such as Whirlpool India, Page Industries, Alkyl Amines, and Vinati Organics, which had PE ratios exceeding 50 as of end 2022, have declined 10% to 70% as most of them posted declines in revenue and profit in the trailing 12 months ended September 2023.
Analysts said the bullish momentum will continue to help companies with strong earnings despite higher PE ratios. “A substantial number of stocks trading with high PEs and a significant portion of these outperforming the market can be attributed to investors leaning towards strength rather than weakness,” said Rupak De, senior technical analyst, LKP Securities. “At present, momentum trading is prevalent, leading traders to favour stocks with rising prices instead of those that have experienced declines.”
