Large financials and insurance companies offer the best risk-reward among sectors at present, according to Abhishek Singh, senior vice president (SVP) and Fund Manager at DSP Mutual Fund.
Singh told NDTV Profit in an exclusive email interview that headline valuations across market-cap segments can hide important nuances, with large caps appearing more reasonably valued across a range of valuation parameters. However, he cautioned that much of this is driven by beaten-down financials.
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“Ex-financials and IT, even large caps are probably not cheap,” Singh said.
Midcaps, meanwhile, look the most expensive on headline valuations, although the quality of earnings can be better in many cases. Singh pointed out that cyclical business peaks can inflate margins and make price-to-earnings multiples look deceptively attractive on the way up.
“In my view, large financials and insurance offer the best risk-reward,” Singh said. “On a relative basis, commercial real estate also looks interesting.”
Singh's preference comes against a backdrop of elevated overall market valuations. The Nifty 500 is trading at around 23 times earnings, while the Sensex is at roughly 21 times. He said markets are currently around 10-15% above historical valuation averages.
Historically, equities have generated similar headline returns in aggregate when earnings growth was around 12-13%, he said. However, starting valuations being above average means multiples are more likely to work against investors than for them over the medium term.
Singh also pointed to the impact of inflation on nominal earnings growth. With India currently in a lower-inflation regime, nominal earnings growth in a 5% inflation environment cannot look the same as nominal earnings growth in a 7% inflation environment.
“Given these two factors of starting valuations being above average and a lower inflation base, aggregate equity returns over the medium term are likely to be lower than what we have seen historically,” he said.
However, Singh said investors should focus on real rather than headline returns.
Investors, he said, should be broadly indifferent between earning 13% in a 7% inflation regime and 11% in a 5% inflation regime, adding that returns that look lower than those of the past decade could still be perfectly respectable in real terms.
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