Value stocks fail to beat overvalued, fairly valued shares; 100 stocks’ study shows surprising best performers

A recent research report analysing the performance of overvalued, undervalued, and fairly valued stocks in India’s top 100 companies has challenged the conventional market wisdom, which expects cheaper (undervalued) stocks to outperform expensive (overvalued) shares. “Fairly valued stocks deliver better returns than both over- and undervalued scrips, per our analysis of forward PE and stock returns,” BOB Capital Markets said in a note last week. Not only this, Bobcaps research showed that the performance of even “overvalued stocks tends to be better than those that are undervalued”, analyst Kumar Manish said in the note.

A very interesting finding of the study was that certain stocks continue to remain undervalued or overvalued. Such stocks have consistently been considered either too expensive or too cheap relative to their intrinsic value, indicating a lack of fluctuation in their valuation multiples over time. “A few stocks have consistently figured in the overvalued and undervalued buckets, underscoring the absence of change in their extreme multiples,” the note said.

With the help of the following chart, the study shows that fairly valued stocks delivered a better performance on average for most years while both overvalued and undervalued stocks had a mixed run.

Background and Methodology: The research report examined the top 100 stocks in India over the past decade. During this period, the Nifty 50’s one-year forward PE multiple has expanded to 19x, with most companies also experiencing an increase in their forward multiples.The analysis utilised a daily time series to calculate the ratios of individual stock’s forward PE multiples to that of the Nifty 50 over the past ten years. These ratios were then categorised as overvalued, undervalued, or fairly valued based on their distance from the mean in terms of standard deviation.

The subsequent performance of stocks in each category was evaluated over the following one-year period from the date of classification. This analysis was repeated for each of the last eight years, excluding the Covid-impacted year of 2020-21. The report emphatically notes that past performance does not guarantee future outcomes, albeit mentions that these findings challenge the notion of value picking and invite a reconsideration of investment strategies.

Steady multiples for some stocks: The study identifies a group of stocks that have consistently appeared in the overvalued and undervalued categories, indicating a lack of change in their extreme multiples. Notably, stocks such as PIDI, HAVL, SRF, DIVI, and RIL have experienced steady expansion in multiples, while BPCL, IOCL, GAIL, AXSB, COAL, and DRRD have consistently seen contraction compared to NSE Nifty 50.

Here is the full list of India’s top 100 stocks, currently classified into overvalued, undervalued, and fairly valued categories by Bobcaps.