Over-exuberance (read, greed) has led to most sectors and stocks in India being overvalued, and the market is happy to overpay for weak business models in some cases and unsustainable high profits in others, Kotak Institutional Equities said in a report.

Investors also do not seem to care about the potential risks of investing in companies with weak business models and superficial narratives, paying little attention to fundamentals, risks, and valuations.

The report said that overvaluation is high in the case of several low-quality companies and low for most large caps. The financial sector was an exception, with most stocks trading at reasonable valuations., it observed.

Valuation warning

The rich valuations of the Indian markets did not reflect the true levels of overvaluation in many parts of the market. Valuations of companies in the consumption, investment and outsourcing sectors have run up sharply compared to the pre-pandemic period.

The report pointed out that most large-cap consumption stocks are trading at expensive valuations. For instance, stocks of companies such as Bajaj Auto, TVS Motors, Asian Paints, Havells India, Nestle India, and Varun Beverages are trading at 30-86 times their earnings per share.

Most mid-caps consumption stocks are trading at very expensive valuations.

Even if the current high profitability in several sectors sustain, the valuations still look high. The correction in raw material prices in the current fiscal year, along with price increases taken by many consumption-oriented companies, has boosted their profitability. Many companies have held on to high product prices despite significantly cooling input costs. However, the competitive intensity has increased, and whether their profitability is sustained ., and valuations are justified has to be seen.

“The high valuations of the stocks in automobiles & components, consumer durables and apparel, commodity chemicals and oil, gas & consumable fuels (downstream refining and marketing companies) sectors would suggest that the market does not expect any decline in profitability from current super-normal levels,” the report pointed out.

Market sentiment vs fundamentals

The market is also ignoring the threat of disruption that has been accelerating across sectors. The disruptions are from the environment, formalisation in the sector, standardisation, and technology.

“The market perhaps believes that these threats are too far away or not relevant for their preferred sectors. However, in many sectors, the threat is very near and real, in our view,” the report said, adding that when the market becomes aware of the risks, it will lead to a derating of multiples.

The wide disconnect between elevated prices and fundamental values of stocks is likely to sustain until some event, either global or domestic, results in a risk-off sentiment in the market from the current ultra-bullish sentiment and fundamentals become more relevant in the market as opposed to the current domination of sentiment, the report said.