The Indian equity market has been recording a dispersion of valuations (disconnect between EPS growth differential and PE differential) among the MSCI India stocks. This dispersion of valuations has reached an all-time high due to which the market could see a significant risk to P/E multiples, according to a Bank of America Merrill Lynch (BofAML) report.
“Investors continue to ‘herd’ into a few select companies, which is a risk. As a result, there is a lot of extremes building up in the valuations. That is no longer the case for other indices,” shared Sanjay Mookim, director of global research at DSP Merrill Lynch, a Bank of America arm.
More than 70% of incremental profit growth in Nifty has come from four stocks — HDFC Bank, ICICI Bank, SBI Bank and RIL.
The BofAML report suggests that MSCI India is currently still in the high expectation/high PE zone. Additionally, global support for expensive Indian stocks has ended as RBI’s liquidity injections have now turned negative, and are forecast to remain at/below zero as the US Fed continues its quantitative tapering. “Abundant liquidity had also led to a hunt for returns and the willingness of investors to take on greater risks.
Globally, this had led to a significant rerating of P/E multiples for growth stocks. As this tide of liquidity turned and opportunity cost of capital has risen, multiples for growth have started to fall,” the report added. If EM is now under pressure due to deteriorating global macro/lower liquidity, then India is very likely to be affected by the same concerns.
The difference between the one-year forward P/E of the top 10 percentile stocks and the bottom 10 percentile MSCI India stocks has widened. In 2007, the difference was between 15-20 and in September 2018 the difference has reached between 40-45. On the other hand, forward EPS growth difference between forecasts for the top 10 percentile and bottom ten percentile of MSCI India stocks has fallen between 50-100% in September 2018 against 100-150% in January 2007. This continues to rise even as the difference in forward growth forecasts has fallen. However, the difference in growth between the top 10 percentile and the bottom 10 percentile stocks is close to all-time lows.
Also read: Sensex surges 465 points, Nifty gains 1.4%; three key factors behind the rally
While the dispersion of P/E for MSCI Indonesia has also risen over the last few years, it remains below peak and is relatively stable. Other EM countries wherein the dispersion of P/E and EPS remains stable include FTSE JSE Africa, MOEX Russia Index and Stock Exchange of Thailand, showed Bloomberg data.