'Over the next 12 months, it will be difficult to make 15 to 20 per cent return in the markets as the valuations appear stretched.'
Propelled by liquidity, the stock markets have been rising over the past few months and the main indices, the BSE Sensex and the Nifty 50, have reclaimed 82,000 and 25,000 levels respectively.
The run-up has made valuations expensive and analysts say they expect the rally to take a breather for the next few months as corporate earnings catch up.
A look at the valuation metrics in terms of price-earnings (PE) of the frontline indices on the National Stock Exchange (NSE) suggests that Nifty 50 index is trading at 24.7x, which is in line with its five-year average but a tad higher than the 10-year average of 23.4x, according to Bloomberg data.
PE ratio is the gauge of a company's stock price relative to its earnings per share (EPS).
Experts use it to analyse the valuation of a company's stock with its five or a ten-year average.
A high P/E compared to five or ten-year averages indicates that the stock is overvalued, or the markets expect a higher rate of growth.
Out of the eight frontline sectors that include banks, information technology, metals, real estate, public sector enterprises and auto, five are currently trading at a higher PE multiple compared to their 10-year average, Bloomberg data shows.
The Nifty Midcap 100 index at 47x PE is far away from its five-year average of 36.4x and 10-year average of 32.4x.
Valuations are a big overhang for foreign investors when they consider investing in India, said Bhaskar Laxminarayan, chief investment officer for Asia and head of Asian investment management at Julius Baer.
"In fact, the biggest conversation we have with them is on valuations of (the) Indian markets. The next is politics. Every investor understands India's growth story but valuation is a worry.
"Valuations of largecaps is not much of a worry as is the case in the small and midcaps and microcaps. We prefer the largecap space in the Indian context. Within sectors, we like the consumption and infrastructure sectors," said Laxminarayan.
In P/E terms, data shows Nifty 50 is trading at around 89 per cent premium to the MSCI EM index and above its historical average of around 50 per cent.
Stable macroeconomics, broad-based earnings growth and robust banking/corporate sector health are driving this premium, said analysts.
That said, geopolitics, elections in the United States and crude price remain key risks, especially after the recent escalation in the conflict in West Asia.
Any change in the Indian government's fiscal priorities after state elections can also emerge as a medium-term risk, according to analysts.
Banks, fast moving consumer goods, Larsen & Toubro and Reliance Industries are sectors and stocks where G Chokkalingam, founder and head of research at Equinomics Research, finds valuation comfort at current levels.
"Over the next 12 months, it will be difficult to make 15 to 20 per cent return in the markets as the valuations appear stretched," Chokkalingam says.
"That said," he adds, "I would prefer to be in largecap stocks as opposed to mid-and smallcaps purely from a risk-reward scenario. One needs to be selective."
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Feature Presentation: Aslam Hunani/Rediff.com
