Conversely, nine sectors are trading at a premium compared to their long-term averages. They are auto, banks, NBFC, cement, consumer, retail and IT, among others
You don’t have to be an expert on every stock to find great businesses trading at fair or better prices. - Warren Buffett
Valuation is one of the key factors for investors to buy a stock. No wonder many successful investors have underlined the importance of right valuation.
Presently, as many as six sectors are trading at a discount to their long-term averages. Among them are capital goods, healthcare, infra, media and metals, according to a report from Motilal Oswal.
The brokerage house in its research report compared the current Price-to-Earnings (P/E) multiple with that of average P/E multiple seen in the last 10 years.
Capital goods sector, trading at a P/E multiple of 24.5x, is at a discount of 9 percent to the 10-year average of 26.9x. Even on P/B (price-to-book) basis, the sector trades at a discount of 6 percent to its 10-year average multiple of 3.4x.
Similarly, the metals sector is trading at a P/E multiple of 9.9x, at a discount of 19 percent to the 10-year average of 12.3x. On P/B basis, the sector trades at a discount of 23 percent to its 10-year average multiple of 1.4x.
Now the question is: Is it the right time to dig into sectors that are trading at a discount to their long term averages?
Well, the answer is both yes and no. Experts suggest that even though many sectors are trading at a discount to their long-term averages, not every sector is a long-term buy.
According to them, out of six sectors that are trading at a discount, capital goods and infra have the potential to deliver long-term returns to investors.
“The quantitative measures for healthcare, media and metal sectors are well below their long-term averages and yet to display significant signs of reversal. Healthcare and media are likely to prolong their underperformance on a medium-term basis based on their respective market internals,” Arun Kumar, Market Strategist, Reliance Securities told Moneycontrol.
“However, capital goods and infra sector have managed to climb their hurdles and are currently better placed than healthcare, media and metal sectors. These two sectors will definitely benefit and outperform once the investment cycle picks up,” he said.
What should one do with sectors that are trading at a premium?
As many as nine sectors are trading at premium valuations compared to their long-term averages. They are auto, banks, NBFC, cement, consumer, retail and technology, among others.
PSU banks are trading at a P/B of 1.0x, in line with the historical average of 0.9x. Their valuations have recovered gradually due to the recent capital infusion by the government and improving earnings trajectory.
Despite a sharp fall seen in this space, the auto sector is trading at P/E of 18.1x, at a 7 percent premium to its historical average of 16.9x.
While wholesales have declined continuously led by the high base and weak demand sentiments, Motilal Oswal believes that the normal monsoon forecast and BS6 related pre-buying should drive volumes from 2QFY20.
Investors should be more cautious of sectors that are trading at a premium compared to sectors that are trading at a discount.
The auto sector has been under pressure since the last financial year. The internals of this sector is yet to signal a strong reversal, therefore, it could underperform for a couple more quarters.
Sectors that could deliver consistent returns are consumers, to some extent IT and PSU banks.
Mayuresh Joshi, Portfolio Manager, Angel Broking Ltd explains the status of sectors that are trading at a premium:
• NBFC valuations are at around 26X P/E, against the historical average of 19, so the premium is steep. A lot of it could be due to the weaker profit numbers due to the liquidity crisis and higher cost of funds. One should be extremely stock specific.
• PSU banks are in a similar situation and they have taken huge losses even in the March quarter. That is creating an optical illusion of overvaluation compared to historical P/E ratios. But the advantage here could be that the NPA cycle may be near the bottom.
• Information Technology is seeing a lot of safe-haven buying. While the operating margins have shrunk, IT remains a high profit and above average growth industry even in tough times. With pharma becoming too cyclical, investors are veering towards FMCG and IT as a defensive play.
• Auto sector could feel the brunt of demand slowdown on one hand and leverage pressures on the other. Auto stocks have corrected nearly 30 percent from their peak levels and could offer if off-take picks up.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.