The Indian stock market has been on a remarkable run, with the benchmark indices up 18-20% in the last year. However, a closer look reveals that the market may be overvalued across most sectors, according to a recent report by Kotak Institutional Equities[1][5].

Overvaluation Across Sectors

The report finds that over-exuberance (greed) has led to most sectors and stocks in India being overvalued, with the market willing to overpay for weak business models and unsustainable high profits[1]. The level of overvaluation increases in inverse order of market cap, quality, and risk[2].

Most large-cap consumption stocks are trading at expensive valuations, with companies like Bajaj Auto, TVS Motors, Asian Paints, Havells India, Nestle India, and Varun Beverages trading at 30-86 times their earnings per share[1]. Mid-cap consumption stocks are also trading at very expensive valuations[1].

Exceptions and Risks

The financial sector is an exception, with most stocks trading at reasonable valuations[1]. However, the high valuations of stocks in sectors like automobiles & components, consumer durables and apparel, commodity chemicals, and oil, gas & consumable fuels suggest that the market does not expect any decline in profitability from current super-normal levels[1].

The market is also ignoring the threat of disruption that has been accelerating across sectors, such as from the environment, formalization, standardization, and technology[1]. The dichotomy between weak consumption demand for staples and parts of discretionary sectors and strong investment demand, especially for premium real estate, reflects continued challenges of low-income households and decent financial condition of high-income households[2].

Macros, Mania, and Modi

Indian Stock Market in Modi 3.0

Despite the rich valuations, Kotak sees three factors supporting the market for now: macros, mania, and Modi (Prime Minister Narendra Modi)[2]. The large ‘disconnect’ between price and value may sustain if the BJP wins the forthcoming national elections, as is widely expected, and the market continues to ignore potential medium-term disruption risks[2].

India’s reasonable macroeconomic situation, including strong GDP growth, manageable balance of payments, fiscal and inflation, and a sluggish global outlook providing some tailwind for the market, also support the market[2]. However, weak monsoons from El Nino conditions may further postpone consumption and rural recovery[2].

Reasons for Caution

While the Indian stock market has outperformed emerging stock markets in 2023 and the year to date, some managers urge caution[3]. The inclusion of Indian government bonds in global indices and a financial system that favors entrepreneurship offer opportunities, but many stocks trade at a higher price than other emerging markets[3].

Investors should be aware of factors like rising crude oil prices and the need to boost exports to continue growing[3]. The challenge and opportunity of being a beneficiary of companies’ reduction of dependence on supplies from China, with Apple and Tesla reportedly targeting expansion into India, also present risks and opportunities[3].

In conclusion, while the Indian stock market has been on a roll, the Kotak report suggests that the market may be overvalued across most sectors, with the financial sector being an exception. Investors should be cautious and selective in their investments, favoring companies with sustainable earnings power and discounted share prices[3][5].