What’s behind steep stock market valuations? Kotak’s Sanjeev Prasad has a surprise answer

Retail investors buying regardless of price levels and mutual funds buying due to continued investor inflows are keeping India’s market valuations high, Sanjeev Prasad of Kotak Institutional Equities said, adding India’s slow growth and high valuations are key concerns for foreign portfolio investors.

“How quickly a valuation reset happens depends on how domestic investors, both institutional and non-institutional, react in terms of aligning quickly to the right levels of value for respective sectors and stocks. This will result in a faster correction. If they don’t align, then we have a situation where FPIs will keep selling and domestic investors will keep buying,” said Prasad, managing director and co-head of Kotak Institutional Equities.

"This price-agnostic buying by retail is a valid strategy for 10 to 15 to 20 years. But I don't know how many people follow that strategy," he said on the sidelines of the Kotak Institutional Equities Chasing Growth Conference.

Price-agnostic buying refers to buying across price levels without ascertaining the fundamental value proposition of a stock.

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Prasad's comments come against the backdrop of FPI outflows of ₹2.68 trillion from India's cash market over the past four and a half months. The outflows have been induced by slowing GDP growth and corporate earnings in India and rising bond yields in the US following various tariff-related decisions by the Donald Trump administration.

Apart from price-agnostic buying, forced buying by mutual funds receiving record money through systematic investment plans (SIP) was preventing a valuation reset, he added.

"Besides the price-agnostic buying by retail investors, we see forced buying by domestic institutional investors over the past three to four years. Nobody is looking at the actual value of a stock--price-value proposition which you should do at all price points--Does this stock make sense from a fundamental value perspective versus its price today? That art is forgotten. "

SIP money flows into Indian markets have already jumped by almost a fifth to ₹2.37 trillion in the current fiscal year through January from ₹1.99 trillion in the whole of the preceding fiscal.

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Despite DII buying at over ₹3 trillion since October, the Nifty has fallen 12.7% from a record high of 26,277.35 on 27 September to 22945.30 as on date . The Nifty Midcap 150 has fallen 18.38% from its record high of 22515.4 on 25 September to 18375.85 on Tuesday while the Nifty Smallcap 250 has plunged into bear market territory, losing 23.65% from its life high of 18688.3 on 24 September to 14267.95 as on date.

Stay away from mids and small caps

Prasad said that retail investors could look at large-cap stocks, but cautioned that valuations here too didn't warrant investing in a haste.

"Stay away from mids and small caps," Prasad advises retail investors . "Slowly, consider investing in large-caps. But here too, there is no rush. It's not as if valuations have turned favourable for large-caps either. If you're already invested, what can I say? Live with the pain."

The Nifty currently trades at a multiple of 19.43 times to its trailing earnings against a historic multiple of 18.28 times. Bloomberg data shows that the recent correction in mid- and small-caps has brought down the multiples to below averages since 2017. However, looking at index level multiples could mislead investors, Prasad said.

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"Look at individual stocks across the consumption, investment and outsourcing buckets wherein general valuations now are significantly higher compared to pre-pandemic levels. And in many cases, barring financials, the earnings growth is lower than pre-pandemic levels. In most cases, multiples are higher to significantly higher than pre-pandemic levels. This, at a time economic growth rate is slower, global yields are higher, and medium-term corporate profitability growth challenges are more visible for most companies and most sectors ."

He said that though some smid stocks had corrected by as much as 50% in the recent fall, there was still "more to go in many more stocks. "

FIIs selling, he added, would continue so long as growth and valuation concerns remain. “It's not just about India . In general, asset allocators are pulling out of emerging markets and putting money in developed markets, especially the US, which has outperformed EMs from a one-year, five-year, ten-year and longer time frame.”

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Consumption boost?

On whether the budget's tax cut would move the needle for consumption, Prasad said he didn't think so.

"There are 20 million taxpayers in this country, even though the number of those filing returns is higher. But if you're giving a tax benefit to a high-income household, it's not going to fundamentally alter their consumption behaviour. Say, those earning more than ₹50 lakh will save the money rather than buying more pizzas or cars. Those in the ₹25-50 lakh bracket might consume a little more. The high-income household is doing fine. The slowdown is mostly there in the low-income households, who were anyway below the income tax limit . There is no benefit for them in the tax cut."

He said the biggest challenge to increasing growth was creating more jobs, especially through low-tech, labour-intensive manufacturing.

"There needs to be a great push for low-technology, labour-intensive manufacturing. The government is trying to facilitate growth through ease of doing business, PLI schemes etc, which will hopefully work out, but there is no pick-up on this low-tech front, which will create jobs in a big way in both rural and urban India. Apart from Electronics Manufacturing Services, which involves assembling components, we don't see any investment in creating low-tech labour-intensive jobs."

India's GDP growth in FY25 is estimated at 6.4% against a provisional 8.2% in the previous fiscal.

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