The equity market is facing headwinds after making a new lifetime high earlier this month. The benchmark BSE Sensex is down nearly 1.5 percent in the last five trading sessions. The decline was triggered by lower-than-expected earnings growth by index heavyweights such as Reliance Industries and Infosys. In general, corporate earnings growth was lower than expected during the April-June 2023 quarter (Q1FY24) and it is putting pressure on stock prices and valuation despite strong buying by Foreign Portfolio Investors (FPI).
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Many analysts believe that corporate earnings could be muted in FY 2023-24 due to the combined effect of a slowdown in revenue growth, higher interest expenses and a global slowdown. This could translate into a cautious mood on Dalal Street.
The pressure on margins and net profit could however be more acute for mid and small-size companies while large-cap companies and market leaders may still manage to grow though at a slower pace than in the previous two fiscal years.
Moreover, companies with large global operations are expected to be less impacted by any economic and demand slowdown in the Indian domestic market.
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This puts large-cap stocks in an advantageous position compared to mid and small-cap stocks. Given this, investors are advised to rebalance their portfolio in favour of large-cap stocks and reduce their exposure to mid and small-cap stocks. In comparison, mid and small-cap stocks have outperformed large stocks and benchmark stocks in the last 12 months.
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Large-cap stocks are not only expected to offer faster earnings growth over the next 12 months but would also be less volatile compared to mid and small-cap stocks in case of a sell-off in the market.
The best way to play this market is to invest in large-cap stocks that are trading at a discount to their intrinsic value given their profitability ratios such as return on equity (RoE).
For example, the BSE 500 index is currently trading at a trailing price-to-earnings multiple of around 25X. In comparison, the stocks that are part of the index have an RoE of 14.1 percent on average. This translates into a P/E multiple to RoE ratio of around 1.8X for the index.
In comparison, this valuation ratio is much lower for many large-cap stocks despite these companies having a much higher return on equity. A company with a higher RoE tends to grow faster than its peers and is less likely to face financial difficulty in times of recession.
Here are ten large-cap stocks that are relatively cheap on this metric and are expected to grow faster than their peers. All stocks in our basket have a much higher RoE than that of the broader market but their valuation ratios are still comparatively lower.
1. At the top of our list is oral-care products maker Colgate-Palmolive. The stock is currently trading at a trailing P/E multiple of 45.5 times against its latest return on equity of 65.6 percent. The stock also offers a dividend yield of 2 percent, one of the highest in FMCG stocks. The stock is up nearly 25 percent in the last one year and could rise further.
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2. The IT services exporter Tata Consultancy Services (TCS) is next in our basket with a trailing P/E multiple of 28.3X currently and a price-to-book value of 13.7X. Against this, the company reported an RoE of 48.4 percent in FY243, one of the highest in its industry. The stock also offers a dividend yield of 3.4 percent - one of the highest in the large-cap space.
3. It is followed by Infosys which is currently trading at a trailing P/E of 22.7X, against its latest return on equity of 32.7 percent. The stock has faced some rough weather after its Q1FY24 earnings but the storm will pass and is expected to outperform the broader market over the next 12 months. The stock also offers higher than the market dividend yield of 2.5 percent currently.
4. India's global automaker Tata Motors is next on our list. The stock is trading at a trailing P/E of 21.1 and price to book value of 5.2X. In comparison, the company RoE has now increased to 24.4 percent from a single digit a year ago. The stock is up nearly 40 percent in the last one year but could rally further given its growing automotive business in India and overseas.
5. The two and three-wheeler maker Bajaj Auto comes next with a trailing P/E of 21.1X and price-to-book value of 4.7X currently. In comparison, the company reported a return on equity of 22.3 percent in FY24 - among the best in the two-wheeler space. The stock also offers a relatively high dividend yield of 2.9 percent currently.
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6. The pharmaceutical major Dr Reddy's Labs is the sixth company on our list with a trailing P/E of 19.3X and price to book value of 3.9X currently. Against this, the company reported an RoE of 20.3 percent in its latest trailing 12 months. The stock is up nearly 30 percent in the last 12 months and could rally more.
7. The Indian subsidiary of global foods major Nestle India is the next stock in our basket with a P/E of 86.5X and price to book value ratio of 42.7X. Both these ratios are among the highest among listed companies but are justified by their consistently high RoE of over 100 percent. The company is also among the top dividend payers in the country.
8. The public sector power major Power Grid Corporation comes next with a trailing P/E of 11.4X and price to book value ratio of 2.1X. Against this, the company reported an RoE of 18.6 percent in FY23. The stock also offers a relatively high dividend yield of nearly 6 percent at its current stock price.
9. The private sector lender Axis Bank is the ninth stock on our list. The stock is currently trading at a P/E of 13.2X and price to book value of 2.3X. Against this, the bank reported an RoE of 17.6 percent last fiscal among the highest in its industry.
10. India's second-largest private sector lender ICICI Bank is the last stock in our basket with a P/E multiple of 18.7X and price-to-book value ratio of 3.3X against its reported RoE of 17.4 percent on a trailing 12-months basis.
Happy Investing!
(Disclaimer: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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