The brokerage has been cautious on the mid- and small-cap space for the last three to four months, and following the recent rally, it believes that mega-cap stocks are also no longer value propositions.
“It would appear that investors are taking their cues from incremental developments and events and ignoring the fact that absolute valuations may already be pricing in the positive developments (real or even purported),” said Kotak in a note to clients.
While the Nifty 50 index has gained a little over 20% so far in 2023, the broader market has seen a significant outperformance, with the NSE Midcap 100 gaining over 45%, and the NSE Smallcap 100 surging nearly 55%.
Automobiles and their components, electric utilities, and IT services are among the sectors that have the maximum distortion in terms of price and value, and it would be best if these sectors were avoided, it said.
The brokerage cited Bharat Heavy Electricals and NTPC as examples of exuberance among investors, terming the valuations of these state-owned companies on the higher side “by a distance”.
While absolute valuations remaining ‘high’ should drive a convergence between prices and value, the current divergence in the market could be sustained if investor sentiment continues to overpower fundamentals, according to Kotak.“The year could finally see a convergence between price and value or a continued large disconnect between price and value, the case for the past 6-9 months,” the brokerage said on Thursday.
Incremental news flow that could sustain this ‘price-value’ gap includes the country’s macroeconomic fundamentals, expectations of lower interest rates globally, and the reduced risk of elections after the BJP’s strong performance in the recent state elections.
It sees net profits of the Nifty-50 index growing by 11% in FY25, but sees limited scope for earnings upgrades in the context of benign profitability and volume assumptions across sectors.