Undervalued Stocks at Attractive Prices

The current market sentiment is weak and the stock prices have dropped considerably from their respective highs. This presents a very good opportunity to add high-quality stocks to your portfolio. Yogesh Supekar highlights how some of the consistent compounders are available at discounted prices post correction 

Gold is shining once again with the precious metal hitting its all-time high and is expected to gain some weight given the macroeconomic conditions and the geopolitical situations. Gold is also shining brighter as the other asset classes are not doing much recently. Both fixed income and equity have been underperforming the precious metal. It has been one of those rare instances where any investor who has diversified into fixed income and equity may have burned fingers in both the asset classes in 2022 and in 2023 so far. We are used to seeing a negative correlation between equity and fixed income asset class but the story has been different recently. [EasyDNNnews:PaidContentStart]

In the US markets, according to Bloomberg, the 10-year average of bond-stock correlation is minus 25 per cent but it hit a 23-year high of positive 45 per cent in 2022. When we have a banking crisis in the developed world, things don’t look bright for financial assets. The banking crisis in the US and Europe is leading to a broad-based sell-off in the global equity markets. The sell-off in the Indian markets is in line with the global markets’ weakening sentiment. BSE Sensex is down by nearly 8 per cent from its highs while BSE Small-Cap index is down by ~9 per cent. Several stocks have been battered down heavily, thus underperforming the key benchmark indices.
 

Pain Areas

The recent meltdown in the market is seen having its worst impact on the broader markets. The so-called growth stocks of the world are the ones where we have seen massive correction. The stocks that were trading at unrealistic valuations and the ones which have multiplied in stock prices are the ones where we are witnessing profit booking. Commenting on this scenario, Parag Mehta, a long-term investor who believes in growth investing, says, “Some of my portfolio stocks are down by nearly 50 per cent from my purchase price. These are the same stocks which promised abnormal growth. When the markets were in an uptrend these stocks simply proved to be irresistible. I think I bought momentum stocks and the market sentiment simply reversed, which led to heavy correction in highly valued stocks. In hindsight now I realise that these were overvalued stocks that I bought at high prices. Even though on the ground the business is good for the said companies, the stock prices have corrected by almost 50 per cent. Now I am not sure if I should exit or whether I should add to my position.”

Indeed, the growth stocks have been battered the most in the recent market correction. The same cannot be said about value stocks which have also corrected but the correction is not as deep as seen in the growth stocks. According to Naveen Kulkarni, Chief Investment Officer, Axis Securities PMS, “Quality companies correcting is generally a sign of technical correction in the market and not a fundamental change in view. While some quality companies have structural challenges, the economic activity in India continues to remain at good levels. Thus, the current correction in the market should be used to accumulate quality stocks as they have become value picks now. Buying quality companies without paying a premium is the best value investing strategy, which has a very high success rate.” 

He further adds, “FY24 could be a challenging year for the market during the first half as the market will continue to adjust to a higher rate regime. However, interest rates might peak by the first half of FY24 around the world. By the end of the first half, the market will start factoring in the possibility of rate cuts in the second half. This will help the equity markets. While the interest rate cycle is a global macro cycle, India Inc.’s earnings cycle is likely to remain resilient over the next two years. Earnings visibility continues to be good across sectors, and this provides good return visibility. We can expect equity returns in the range of 12-15 per cent in FY24, which is good considering that FY23 was a sluggish year. Overall, FY24 is likely to be better than FY23 due to valuation compression and continued earnings’ visibility. The interest rate cycle peaking by mid-FY24 will also help the markets.”
 

Fishing for the Best 

One area where investors can look at is the bunch of stocks that are high in quality parameters and have fallen only due to technical reasons and not owing to the change in the fundamentals of the company. The sectors which are focused on the domestic consumption story can also be a good bet as the global economy faces slowdown and recessionary risk. Value stocks are always a good choice in the times when the overall market mood is that of risk-off. The growth stocks usually get punished harshly when the market sentiment turns sour. FPIs have also been on a selling spree with almost Rs 22,652 crore worth of shares sold in calendar year 2023 so far. In the similar period, FPIs have pulled out Rs 2,550 crore from the debt markets. One sector where the FPIs have been consistently buying is capital goods. Investors can hunt for opportunities in the capital goods sector along with the pharmaceutical sector where there seems to be lot of under-pricing. The table below explains the underperformance of pharmaceutical stocks.
 

High PE Stocks Vs LOW PE Stocks Performance in 2023 

If we consider the data for the BSE 500 stocks and take a sample of the top 20 stocks with the highest PE or PE greater than 100 and check the average performance, we find that the average returns are around -18.17 per cent for the 20 stocks with high PE multiples. At the same time, as is reflected in the tables below, we find that the average returns of the 20 stocks with low PE multiples are around -12 per cent on YTD basis. This goes to show that high PE stocks do tend to get punished harder during the market correction phase than low PE stocks.
 

Conclusion 

We have seen in the past that equity markets have almost always bounced back climbing the wall of worries. However, it does not mean that the markets cannot fall further from the current levels. The recent market correction is characterised by rising interest rates and the market has been clinging to the thought that the interest rates have peaked out. Robust employment data in the US’ economy and aggregate demand showing no signs of cooling off is creating a Catch 22 situation for the US Federal Reserve. On the one hand the economic data is robust, leading to increasing demand which means that the inflation levels will remain high and that will not allow the US Federal Reserve to stop raising interest rate and on the other hand if the rates continue to rise, it will continue to create a systemic risk to the banking system in te US as has been seen in the fallout of the Silicon Valley Bank (SVB). 

If the Federal Reserve decides to support the falling banks and the depositors as it did in the case of SVB, it will essentially indicate that it is printing money, which defeats the purpose of raising interest rates. Looking at the complex situation faced by the central banks of the developed western economies, the situation can get murkier for the equity markets and we might be looking at additional bouts of volatility in both the near term and the medium term. Such volatility induced by economic uncertainty can create excellent opportunities for long-term investors. Already the stock prices have corrected by a good margin and any dip from the current levels actually provides further margin of safety for the investors.

The current situation is one of those where value exists in both growth stocks as they have corrected and in value stocks which have corrected marginally. As an active investor the rewards are definite for those who can identify the stocks that have corrected heavily with no material changes in the fundamentals of the company. For high-risk investors there is a lucrative opportunity in illiquid counters which have fallen by more than 50 per cent from their respective 52-week highs only due to selling pressure as investors have preferred to hold on to cash. With negative sentiment, it is tempting to hold on to cash just as most of the mutual fund managers are doing right now. However, being an opportunist when others are pessimistic can add some alpha to the portfolio even though stocks’ selection will have to be prudent. 

[EasyDNNnews:PaidContentEnd] [EasyDNNnews:UnPaidContentStart]

[EasyDNNnews:UnPaidContentEnd]