Are Public Sector Bank Stocks Overvalued, Undervalued, or Correctly Valued in Indian Bourses?

Public sector unit (PSU) stocks have been on a remarkable upward trajectory in the last year, with impressive returns for investors. However, market analysts are raising concerns that these stocks may be overvalued. This article will delve into the current valuation metrics of PSU stocks and provide an in-depth analysis to help investors understand the current state of these investments.

Recent Performance of PSU Stocks

Over the past year, PSU stocks have seen substantial returns, compared to other key indices:

Nifty 50: 30% Nifty PSE: 94% Nifty PSU Bank: 85%

This robust performance has drawn attention to potential overvaluation risks. We will examine the indicators that suggest PSU stocks might be becoming too expensive.

Valuation Metrics and Overvaluation Concerns

To determine whether PSU stocks are overvalued, we will analyze the price-to-earnings (P/E) and price-to-book (P/B) ratios. These metrics are commonly used to assess the relative value of stocks.

Nifty PSE Index Analysis

The current P/E ratio of the Nifty PSE index stands at 9.63, which is higher than its usual median since April 2020, which was 8.4. This suggests that PSU stocks might be trading at a premium, indicating possible overvaluation.

Nifty PSU Bank Index Analysis

The current P/B ratio for PSU banks is 1.54, which is significantly higher than its usual median of 0.81. This again suggests that many of these stocks are being bought at higher prices than they might be worth, indicating potential overvaluation.

Stock-by-Stock Analysis

Given that a group of PSU stocks might be overvalued, we have conducted a more detailed analysis on a stock-by-stock basis to see the distribution of valuations.

Non-Finance Companies

Out of the 56 non-finance PSUs analyzed:

7 stocks do not have valid P/E ratios due to recent losses. 11 stocks are currently trading at P/E ratios lower than their 5-year average. 38 stocks are currently trading above their 5-year average P/E ratios.

The list of 11 stocks trading at a discount can be considered a starting point for investors looking for reasonably priced PSUs. However, many companies like those in the oil and metal sectors are cyclical businesses, which means their profits can fluctuate dramatically over time.

Concerns Within the PSU Stock Market

There are two significant concerns:

Many PSUs are experiencing higher profits without corresponding revenue increases. This could be due to cost-cutting measures or better margins. However, sustained profit growth without revenue growth is not sustainable in the long run. While some stocks may not show impressive profit growth, their prices have risen. This could indicate the presence of a bubble in the market, leading to overvaluation.

Finance Companies

The P/B ratio is used to gauge the valuation of finance companies.

No stocks are trading at a discount compared to their average 5-year P/B ratios. 17 stocks are trading at a premium of 50 or more compared to their average 5-year P/B ratios. Despite a median profit growth of 30%, their income growth remains in single digits, raising questions about the sustainability of this growth.

However, three companies stand out as being attractively valued, with a premium of only 0-10 compared to their average 5-year P/B ratios. These companies are worth investigating further.

Conclusion and Investment Advice

With many PSU stocks experiencing significant price increases despite modest profit growth, investors should be cautious. While exiting PSUs entirely might not be necessary, it is advisable to closely examine the PSU stocks in your portfolio. This can help ensure you make informed investment decisions.

Public sector bank stocks may be overvalued, undervalued, or correctly valued. The recent surge in returns is notable, but potential overvaluation signs should not be overlooked. Conducting thorough research will help investors navigate this rapidly changing market and make sound investment choices.