As Samvat 2081 kicks off, discover the sectors that remain undervalued

As Samvat 2081 dawns upon us, a moderation in market returns in likely, however, some sectors still offer upside potential due to their recent underperformance.

The past year, Samvat 2080, was a bull ride for the Indian equity market, on the back of India's economic outperformance, strong growth prospects, supportive government policy and a focus towards domestic manufacturing. Navigating through key events such as the general election, the union budget, tensions in the Middle East and rate cuts in the US, the market continued to climb one peak after another.

However, as a new year, Samvat 2081 dawns upon us, the market's upward momentum is expected to pause, with returns likely to moderate in the near term. In addition to a slowdown in earnings growth, the high valuations of Indian equities are also a huge catalyst to this deceleration. Despite the elevated valuations in many sectors, however, there are still pockets trading below their historical averages, offering investors opportunities to build positions at attractive prices.

The banking sector, which carries the highest weight in the Nifty 50 index, underperformed during the last Samvat. This underperformance has resulted in the Nifty Bank index currently trading at a one-year forward price-to-earnings (PE) ratio of around 15, significantly below its 10-year historical average PE of 25.

This sharp valuation discount makes the banking sector a relatively attractive option in a market rife with overvaluations. Furthermore, the prospects for banks remain strong, presenting a lucrative opportunity for investors looking to enter the market now.

"With FY25 expected to be a year of earnings normalisation, banks find themselves at the intersection of reasonable valuations and strong earnings growth," said Nitin Bhasin, Head of Institutional Equities at Ambit Institutional Equities.

Bhasin highlighted that private banks are particularly compelling in terms of valuations, pointing out that their profit after tax (PAT) contribution to the NSE500 universe is approximately 14 percent, while their market capitalization contribution is only 8 percent. He believes this discrepancy signals a potential for outperformance for banks in the near term.

Nifty Auto offers valuation comfort

Like the Nifty Bank, the Nifty Auto index presents attractive valuation opportunities for investors, currently trading below its historical averages with a one-year forward price-to-earnings (PE) ratio of 27, compared to its historical average of 35.

However, despite this valuation comfort, not all segments of the auto sector exhibit equally promising growth prospects. While two-wheeler manufacturers are seeing a rebound after a post-COVID lull, the commercial and passenger vehicle segments are experiencing a slowdown due to seasonal lulls, heavy rains, and overall sluggish economic growth.

Therefore, while the sector provides reasonable valuations, investors should proceed cautiously, focusing on stocks with strong earnings visibility to support long-term growth.

Metal names look cheap

Aside from banks and autos, the metal sector is also trading at cheaper valuations as compared to historical averages, largely bogged down the by global headwinds of sluggish demand, and an influx of low-cost Chinese inventory in the last two years. The sectoral index currently trades at a one-year forward price-to-earnings (PE) ratio of 19, lower than its historical average of 22.

While the sector remains high-risk and volatile due to its reliance on global commodity prices and Chinese demand, recent trends offer some optimism. China's mega stimulus efforts to revive its battered property sector may boost demand for metals, though past attempts have often fallen short.

Despite these uncertainties, several tailwinds could support metal manufacturers. Nomura points towards improving domestic demand from the auto and construction sectors, shifts in monetary policy, recent capacity expansions, potential anti-dumping duties, and favourable coking coal prices as tailwinds for a promising future.

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