Bernstein recommends high-momentum, dividend-yielding PSU stocks amid soaring valuations

PSU stocks have surged in popularity among investors in recent months, sparking a significant rally within a remarkably short timeframe. Notably, 68% of PSU stocks listed in the S&P BSE PSU index have delivered multi-bagger returns over the past year, propelling the index to a remarkable gain of 101% during the same period.

This performance is particularly noteworthy given the pressure PSU stocks faced before embarking on their bullish momentum in 2020. Since October 2020, the index has surged by an impressive 279%, surpassing the broader BSE 500 by 90%. Year-to-date, the index has already climbed by 21%, compared to the broader market's 5% increase.

Amidst this bullish trend, investors are beginning to question the sustainability of the PSU stock rally.

Also Read: Here are the top 5 PSU stocks with dividend yields above 5%

According to the global brokerage firm Bernstein, there are only a few select opportunities within the PSU portfolio that stand out. These opportunities primarily include high-momentum and dividend-yielding stocks with reasonable valuations.

However, the firm advises against chasing PSU stocks solely based on high volume or those perceived as having only simple value.

"Most factors in India are at record valuations on an absolute basis; however, both dividend yield and momentum look attractive on relative valuations. Upward revisions have been a key support, and there is reasonable room for upgrades to continue (more for dividend-yielding names than momentum), "Rupal Agarwal of Bernstein said.

Also Read: Citi replaces RIL with BPCL post Q3 earnings; a look at its model portfolio

"High volume looks the most vulnerable, driven by record valuations, both absolute and relative. The earnings upgrades are also near record highs, along with extreme crowding. Unlike dividend yield, the value portfolio has limited room for earnings upgrades to continue, and the trade looks relatively more crowded. Hence, dividend yield seems to be a better way to play value within PSUs," she added.

Industrials PSUs are the most stretched

According to Rupal Agarwal, Industrials PSU stocks are the most stretched, trading at +2.5 standard deviation (SD) to their 10-year PE average. Typically, PSUs trade at a discount to the market, however, now industrial PSUs are trading at a 35% premium to the broader market. Utilities are the second most stretched PSU sector, trading at 1.5SD levels, she said. 

Also Read: Unless you are averse, buying PSUs seems like a no-brainer, says Emkay

Overall, the PSU index is expensive, trading at 11.2x forward PE and 1.8x PB, which is +1SD to the historical average. However, she pointed out that, relative to the broader market (BSE 500), the PSU portfolio is still trading below the historical mean on 12 month forward. PE and just slightly above the mean on PB.

No meaningful institutional crowding

Foreign Institutional Investors (FIIs) have always preferred private companies over PSUs, and there hasn’t been any shift in this preference in the current cycle. Domestic institutional investors tend to own more PSUs compared to FIIs, however, they have been reducing their ownership in PSU names and increasing in non-PSU names over the last year, she noted. 

FII crowding can be seen at NMDC, Bharat Electronics, HAL, BOB, Canara Bank, Indian Bank, and Union Bank. DII crowding is in Gujarat Gas, National Aluminium Co., Container Corp., Indian Bank, Bank of India, and HUDCO.

Key risks

There has been a reasonable improvement in ROEs and margins for the PSU Index. While many PSU names would stack up well on dividends vs. non-PSUs, the overall index dividend yield has been declining and now sits at 2.8%. 

Also Read: Are PSU stocks riding a bubble? mixed results cast doubt on the rally

"Earnings have been a big driver for PSU names so far, however, analysts have never been so bullish on the earnings outlook (driven by the reform push), even though actual earnings have been flat for a while. This could be a key risk," said Rupal Agarwal. 

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.