Fallen Giants: A Buying Opportunity?

The recent underperformance of several Large-Cap stocks stems from unjustified valuation premiums and weakening financial performance. Many of these stocks were priced for consistent growth, but their recent results failed to meet expectations, leading to sharp corrections. The article considers several case-studies and does an overall analysis to conclude how certain factors have contributed to the fall of the ones who were at the top [EasyDNNnews:PaidContentStart]

Every investor loves a company that reigns supreme, commanding excellent valuations and price. But then, there comes a time when the power fizzles out and the concerned company loses steam like a burnt-out engine. In the Indian scenario, there have been corporate entities that were considered invincible, with their stock prices soaring to dizzying heights. However, the year 2024 has seen several such large-cap stocks in India experience a sharp decline in their stock prices. Stocks that were once the darlings of the market have seen their fortunes decline sharply, leaving investors bewildered and wondering what went wrong. Take the example of Asian Paints, whose share price dropped by 32 per cent in CY 2024, with no crude oil price shock. 

To give you a context of such a fall, even during the global financial crisis of 2007-08, the shares of Asian Paints fell by just 17 per cent when the frontline indices fell by more than 50 per cent and crude oil prices traded north of USD 140 per barrel. 

There are also other large-cap stocks that grossly underperformed the frontline indices in 2024. Even a company like Nestle India saw its share price dropping by 18 per cent – shocking for a company that had never seen a negative return since 2015. India’s largest company by market capitalisation too saw its share price dropping by around 5 per cent. 

The following graph shows the underperformance some of the large-cap entities against Nifty 50 in the calendar year of 2024. 

But is this decline a sign of terminal weakness, or an opportunity for investors to invest in these companies at lower prices? In this article, we will examine the cases of some of these ‘fallen titans’ and explore whether they have the potential to rise again. Before getting into individual details, let us set the background to understand what determines future returns in a stock market. 

High Valuations and Slowing Growth: A Recipe for Underperformance In the stock market, valuations and growth rates play a critical role in determining future returns. Investing in a stock at a high valuation often assumes that the company will sustain strong growth. However, if the growth rate falters, the premium valuation may no longer be justified, leading to underperformance. This mismatch between expectations and reality can significantly impact returns.

During the dotcom boom between 1996 and 2000, Infosys’ share price experienced phenomenal growth, surging approximately 90 times from ₹0.96 (adjusted for split and bonus) in 1996 to ₹90.56 by the end of 2000. This translated into a staggering compounded annual growth rate (CAGR) of 160 per cent. However, most of this growth was driven by a sharp rerating of the stock’s price-to-earnings (PE) ratio, which increased 12-fold from 17 times to 206 times, rather than a proportional rise in earnings. While the company’s earnings per share (EPS) did grow by 3.2 times between FY1996 and FY2001, the bulk of the stock’s return was fuelled by PE expansion rather than fundamental performance. The challenge with such elevated valuations is that even strong earnings growth may fail to deliver meaningful returns in the future if the valuations are unsustainably high. 

This is precisely what happened to Infosys after the dotcom bust in January 2001. Over the next four years, its share price remained stagnant, generating no returns despite continued growth in earnings and revenue. The company’s EPS doubled from ₹94 to ₹186 per share, and its top-line expanded 2.5 times, rising from ₹1,900 crore to ₹4,760 crore. Yet, the stock underperformed due to a sharp correction in valuations, with the PE ratio collapsing from 205 times to 26.46 times—a steep decline of nearly 90 per cent. This episode highlights how excessive valuations, when followed by market corrections or tempered growth expectations, can severely impact future returns, even for fundamentally strong businesses. 

More recently, HDFC Bank witnessed a sharp rerating due to its consistent growth and premium valuations. However, with slowing loan growth and rising competition in recent quarters, the stock has underperformed the broader market. 

Assessing the Relevance of Valuation Metrics to the Broader Market
To determine whether the findings of our previous study are applicable to the general market or specific to individual stocks, we conducted a similar analysis on the Nifty 50 index. Nifty 50’s price-to-earnings (PE) ratio serves as a benchmark for gauging the overall market’s valuation, reflecting investor sentiment regarding future earnings growth. Historically, elevated PE ratios have been indicative of investor optimism, leading to higher market valuations. Conversely, low PE ratios may signal expectations of slower growth or potential undervaluation. For instance, in October 2021, the Nifty 50 PE ratio reached a record high, driven by expectations of economic recovery and sustained earnings momentum. Subsequently, the market experienced subdued returns for several quarters, only to rebound in May 2023. 

Investment Implications and Valuation Analysis
The table below shows the correlation between different valuation parameters and future one-year, two-year and three-year returns. 

PE Ratio: A Mildly negative Correlation
1. Price-to-Earnings (PE) Ratio

• The PE ratio shows a negative correlation with future returns across all time horizons (-0.34 for one year, -0.25 for two years and -0.21 for three years).
•  This implies that higher PE ratios generally lead to lower future returns, indicating that overvaluation tends to suppress gains, while lower PE ratios might signal undervaluation, leading to higher returns.
   

2. Price-to-Book (PB) Ratio

• The PB ratio exhibits a stronger negative correlation than PE, particularly over the two-year (-0.72) and three-year (-0.77) horizons.

This suggests that companies trading at higher PB ratios (potentially overvalued) have lower subsequent returns, reinforcing the significance of this metric in identifying valuations tied to asset values.

3. dividend Yield

• Dividend yield shows a positive correlation with future returns (0.28 for one year, 0.27 for two years and 0.48 for three years).
• Higher dividend yields often indicate undervaluation or stable cash flow-generating companies, contributing to better returns in the medium-to-long term. 

Visualising the Relationship Between Current Valuations and Future Returns 

Scatter Plot Analysis with Regression Overlay
This section presents a visual representation of the relationship between current valuation ratios (PE, PB and dividend yield) and future returns. The scatter plots below display the data points for each valuation metric, along with a regression line that illustrates the trend and correlation between the variables. The regression line (in red) provides quantitative insights into the strength and direction of the relationships between current valuation ratios and future returns. 

Expectations for Future Returns Based on Current Valuations
This analysis underscores the importance of valuation discipline in long-term wealth creation. Investors should consider combining valuation metrics like PE, PB and dividend yield with market cycles and economic conditions to optimise their investment strategies. By doing so, investors can make informed decisions that balance risk and return expectations, ultimately leading to more effective returns. 

1. One-Year Outlook - With the current PE ratio around 22.12, the historical data suggests a moderate expectation for future returns, likely ranging between 8-10 per cent, considering the negative correlation.
2. Two-Year Outlook - Lower correlations for PE and PB highlight slightly improved prospects for returns. Investors might expect 10-12 per cent CAGR if the valuations normalise.
3. Three-Year Outlook - The stronger negative relationship of PB and higher positive impact of dividend yields point to 12-15 per cent CAGR returns, assuming stability and earnings growth. 

In the following pages we will highlight companies that have fallen in year 2024 and what we can expect in 2025 and beyond that. 

High Valuations Meet Weak Earnings
Why These Large-Cap Stocks Underperformed in CY24
To understand why these prominent large-cap stocks underperformed in CY24, we conducted a detailed analysis of their financial performance over the past eight years—from FY16 to FY24—except for Nestle, which follows a calendar year, and thus its data was evaluated between CY15 and CY23. We calculated their growth rates in sales, operating profit and profit after tax (PAT), along with the valuations at which they were trading at the end of FY24. 

This analysis highlights how historically high valuations, coupled with weakening financial performance, contributed to their recent struggles. 

Despite demonstrating strong growth trajectories in prior years, these companies entered FY24 with elevated valuation multiples, leaving little room for disappointment. However, the H1FY25 results reveal slowing sales growth, shrinking margins and declining profitability for many, reflecting operational challenges and rising costs. This imbalance between premium valuations and weakening fundamentals resulted in significant stock corrections, underperforming the broader Nifty 50 index. 

The findings emphasise the need for investors to focus on sustainable growth and realistic valuations to mitigate risks during volatile market conditions. 

Financial Deterioration
The data of H1FY24 versus H1FY25 highlights declining operational and net profits for several companies: 

1. Asian Paints Ltd.

• Sales fell 5 per cent, operating profit dropped 21 per cent and net profit fell 33 per cent.
•  This indicates severe margin pressures, possibly from inflation and the entry of new players in the market that has increased competitiveness. 
   

2. Berger Paints India Ltd.

• Marginal sales growth of 1 per cent with 5 per cent drop in operating profit and 6 per cent drop in PAT.
• Slowing growth and higher input costs are impacting profitability. 
   

3. IndusInd Bank Ltd.

• Despite 15 per cent sales growth, its operating profit dropped 2 per cent and net profit declined 19 per cent, thus showing asset quality concerns due to higher delinquencies in the micro finance book. 
   

4. Tata Consumer Products Ltd.

• Sales increased 18 per cent, but operating profit fell 10 per cent and net profit dropped 21 per cent.
• Profitability challenges suggest rising raw material costs and higher marketing spending impacting margins despite strong revenue growth. 

5. UPL Ltd.

• A 40 per cent drop in sales, 81 per cent drop in operating profit and 99 per cent drop in net profit point to a severe downturn, driven by structural issues or commodity pricing pressures. 

6. Bandhan Bank Ltd.

• Robust performance with 22 per cent sales growth, 21 per cent operating profit growth and 39 per cent PAT growth reflect strong fundamentals. Nonetheless, higher non-performing assets and valuation have led to a downslide in performance. 
   

7. Avenue Supermarts Ltd.

• Sales grew 16 per cent, operating profit increased 14 per cent, and net profit rose 12 per cent.
• This reflects steady growth driven by higher footfalls and improved operational efficiencies despite inflationary pressures. Hence, we saw a little bit of improvement in its share price recently. 

Nestle

• Sales increased by 2 per cent, operating profit remained stagnant and net profit increased by 8 per cent.
• Going ahead, sales of the company might not see stellar growth as in a mature market, the company is already a market leader. Therefore, the company has little scope for exponential growth. Hence, a PE ratio of around 70 times looks on the higher side. 
   

We left the Adani group of companies intentionally as they are mired with different problems and any improvement in their price will take some time. The deteriorating financial performance reflects margin pressures, slowing demand and operational inefficiencies, which are not in sync with the high valuations these stocks commanded. 

Going Forward
An in-depth analysis of the recent downturn in once highflying stocks reveals that their underperformance can be attributed to a combination of inflated valuation premiums and deteriorating financial performance. These companies were priced for sustained growth, but their earnings have consistently fallen short of analyst projections, resulting in weaker performance compared to large-cap indices. 

Prominent examples include Asian Paints, Tata Consumer, and UPL, all of which have faced profitability concerns driven by shrinking margins, subdued demand, and declining earnings that have shaken investor confidence. 

In the paint industry, the emergence of Birla Opus Paints, housed under Grasim Industries (Aditya Birla Group’s flagship firm), has intensified competitive pressures. This new entrant has disrupted market dynamics, and it may take time before the competitive landscape stabilizes. A clear winner in this evolving market is likely to emerge only after the dust settles. Until then, the sector remains a battleground for market share. 

Given these uncertainties, our recommendation is to avoid taking contrarian bets or making speculative purchases in these stocks at this stage. Investors should exercise patience and wait for visible signs of financial recovery and more reasonable valuations before allocating any capital. Furthermore, the economy appears to be entering a phase of slower growth, as reflected in the performance trends over the past few quarters. This reinforces the importance of prioritizing investments in stocks and sectors with stable earnings growth rather than chasing overpriced stocks with unpredictable prospects. 

Ultimately, sailing the current volatile market environment requires a disciplined approach focused on companies with strong fundamentals, sustainable growth potential, and a proven track record of performance. Investors who adopt this strategy are likely to weather the turbulence more effectively and position themselves for long-term wealth creation. 

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