Daily Voice: Better to exit PSU stocks given extreme overvaluation, says Ladderup's Raghvendra Nath

The PSU stocks have seen an impeccable rally in the past 1 year with the PSE Index (public sector enterprise) rising over 100 percent in the same period. This rally was fuelled by the increasing order book in sectors such as railways and energy while the surge in PSU banks was seen due to an improvement in the balance sheet and healthy loan growth. These improvements in the PSE sector coupled with the low float of these companies has caused a euphoria making the stocks runway ahead from their fundamentals.

However, continuing the same growth momentum would be a hurdle for these stocks as they have a knack for slow execution and poor governance. Historically, post elections we have also seen a slowdown in the order book which would cause more problems for the PSE segment.

Coming onto the valuation point of view, the historical PE ratios of railway stocks has been in the range of 10-15 times while currently they are trading at a PE of 30-40 times, PSU banks which used to trade around a P/B ratio of 1 to 1.5 times have almost doubled to trade at a P/B ratio of 2-3 times.

Energy & railway stocks have also seen their PE ratios increase by 20 percent-30 percent from their historical levels. Clearly these stocks have entered into the overvalued territory and it’s just a matter of time before the bubble would burst.

Also read: Small, midcaps to outperform largecaps this year as economy pivots to manufacturing: Emkay

The recent plummet in the markets saw the PSE index fall 10 percent in 5 days, showing signs of concerns in this segment. Considering the high allocation towards this sector, we believe exiting the segment would make sense as they have clearly forayed into a territory of extreme overvaluation.

Is it the good time to bottom fish in the midcap IT space and stay with the same segment instead of largecap IT space?

On macro level, largecaps are trading at relatively attractive valuation as compared to midcap IT space. But the IT companies in general have shown good returns in past 6 months. There are some opportunities in the space, but selective stock-picking will be preferred over betting on the sector.

Do you surprise if the market sees sharp correction in coming weeks despite more tailwinds than less headwinds?

We have seen some correction in past weeks in small and mid-cap index, and the space is likely to experience headwinds in coming days. This is again due to the caution from SEBI, and froth building up in the market.

Due to the rally in the recent past one year, we may experience market consolidation or sideways movement in the near term. But the fundamentally strong companies will bounce back from the corrections relatively unscathed.

Do you think the stress tests in AMC is one of key reasons for nervousness in the equity markets?

We do see it being a key reason for the recent corrections in the markets along with other factors like tax loss harvesting, profit bookings and some caution due to the high valuations in the market. Specially with markets at such high valuations, the bourses are expected to be under stress.

Also read: Mind the gap: the main lesson from MF stress tests

But as we highlighted, the companies showing good numbers are likely to bounce back from such corrections in coming weeks.

Do you still expect significant correction in SME and microcap stocks?

We do see corrections happening in the SME and micro stocks, due to liquidity being sucked out on account of Mahadev betting app scam along with the ED being quite active in the space, which might shy some investors away.

Certain rallies based on hearsay and market momentum are also to contribute to high valuations, and corrections in such stocks are imminent.

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