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A collapse in economic growth has caused indicators such as price-to-earnings (P-E) and price-to-book (PB) to rise to historic highs.
A collapse in economic growth has caused indicators such as price-to-earnings (P-E) and price-to-book (PB) to rise to historic highs.

Investors should not go just by index valuations

Rajeev Thakkar, chief investment officer of PPFAS Mutual Fund, took a more careful approach but added that valuations should be seen in the light of substantially lower interest rates

Fund managers speaking at the Mint Money Conversations, presented by digibank by DBS, on 14 October, urged investors not to be driven by index valuations. A collapse in economic growth has caused indicators such as price-to-earnings (P-E) and price-to-book (PB) to rise to historic highs. The trailing P-E ratio of the Nifty 50 is at 34.87, according to data from the National Stock Exchange. However, India’s benchmark Nifty index has reached the 11,680 mark this week, inching close to its all-time high of 12,377.

“You have to dissect sector by sector, company by company. There are great businesses whose intrinsic value is pretty strong from a long-term point of view. We see good intrinsic value for many companies even if they are slightly expensive relative to the sector from a P-E or a PB point of view," said Jinesh Gopani, head of equity, Axis Mutual Fund.

Rajeev Thakkar, chief investment officer of PPFAS Mutual Fund, took a more careful approach but added that valuations should be seen in the light of substantially lower interest rates. “This year’s earnings are all over the place. No one has a handle on FY21 earnings and you cannot use these earnings to value companies because these are exceptional times. One has to use a sustainable earnings period for measurement. For instance, if you consider pre-covid earnings for this, maybe we are at somewhat elevated levels compared to history, but at the same time you have to realize that the cost of capital is also very different. Bond yields and interest rates are also very low compared to the past and when you lower the cost of capital, the value of equity goes up," he said.

Both Gopani and Thakkar said they invest a significant portion of their portfolio in equities through equity mutual funds. Gopani’s allocation is 60%, while Thakkar mentioned that all his money except for primary residence and retirement corpus is invested in equity.

Thakkar also addressed over-valuation in the context of US equities, particularly technology stocks, which have seen their bull run accelerate in the past six to eight months. “In US tech stocks people are fearful and the market caps are very high for some of these companies. But some of them are also the biggest beneficiaries of covid-19. Whether it is e-commerce, cloud computing or software which enables you to work from home, trends have been very strong for tech companies. Tech companies like Alphabet, Microsoft and Facebook are available at around 35 times earnings so it’s not like they are at exceptionally high levels compared to say Indian FMCG companies. I’m sure there are pockets of overvaluation. Some loss-making companies have run up very significantly," he said.

The scorching rally in Indian IT and pharma stocks also failed to perturb fund managers. The S&P BSE IT Total Returns Index (TRI) is up 48.08% over the past year (as on 14 October). The S&P BSE Healthcare TRI is up 64% over the same period. “Both sectors are very good. There are some great companies in them. In IT, the top two companies in India have delivered spectacular numbers, thanks to adoption of cloud. Covid-19 has helped system integrators like TCS or Infosys and others," said Gopani.

He has a more cautious approach towards the pharma sector. “Pharma becomes more stock specific because there are issues under the US FDA," he said. “You have to see the run-up in pharma and IT in the context of the long period of underperformance in both sectors in the pre-covid period. The price run-up may seem very sharp in the past six months but some of the pharma names may not even have crossed their previous highs," said Thakkar.

IT and pharma still hold promise, noted Asheesh Jain, senior vice-president and head, investments and forex business, DBS Bank, while highlighting the higher risk of sector funds compared to diversified equity funds.

Fund managers, however, added that investors should keep a suitably long-term horizon while investing at this juncture and diversify. “Equities have moved up quite sharply in expectation of things reviving. Match your financial goals with the investments you are making. If you need money in the next three years, maybe fixed income is a better option," said Mrinal Singh, Deputy CIO, equity, ICICI Prudential Mutual Fund. “There are cycles in any business and ups and downs in revenues and profitability. Returns can be back-ended from here on. I don’t know how liquidity will shape up, whether there will be a reversal of liquidity or more liquidity coming into play," warned Gopani. He advised investors to do staggered investment either through SIPs or lump sums in stages and have a long-term view.

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