Recap FY24 – How sectors fared on returns, risk, and valuations

6 Apr 2024 , 11:20 AM

FIRST THE MACRO INDEX STORY FOR MARCH 2024

NSE has released the index-wise performance for its key sectoral, generic, and strategy indices for March 2024. This data is not just about returns; but also, about risk factors (measured by volatility, Beta, covariance and R²) and valuation factors (measured by P/E, P/BV, and dividend yields). How do sectors rank on returns, risk, and valuation parameters? Before we delve into sectors, here is a quick look at generic indices for FY24.

• Since 1 month returns tend to be too volatile, we look at 3 month returns as of the end of March 2024. The Nifty returned 2.92% in the last 3 months between December 2023 and March 2024. However, the mid-cap index did better. For instance, Nifty Mid-cap 100 delivered 4.26% during this quarter. However, the Nifty Small Cap 100 struggled with just 0.98%. Nifty Microcap, delivered 1.69%. The SEBI cautionary note on small stocks appears to have hit the returns on small cap stocks and micro-cap stocks in the quarter.
• However, alpha potential over a longer time frame is more potent in smaller stocks. Over the 1-year period, Nifty delivered 30.08% while the mid-cap index delivered 61.17% and the small cap 70.87%. Despite the late sell-off, the Microcap index gave 86.1% in 1 year. The relative performance is visible over 3-year and 5-year CAGR returns also, but the outperformance gap of the smaller indices is much lower.
• In terms of risk, the mid-cap, small cap, and microcap have a higher level of volatility, although the Beta is very close to 1 for all the small indices. But, more important is correlation. The mid-cap index has a correlation of 0.71 versus the Nifty and for the small cap it is 0.61, while for the microcap, it is 0.53. Apparently, the smaller the index, the advantage is not only in alpha, but also in a good diversification story to the Nifty.
• What about macro index valuations? Nifty looks relatively undervalued with P/E ratio at 22.8X and dividend yield of 1.2%. All the smaller indices have a much higher P/E and a much lower dividend yield, despite the late correction in March 2024. One interesting trend is that the mid-cap index is the most richly valued in terms of P/E ratio at 32.89X, while small cap and micro-cap indices are much lower on the valuation scale.

At a macro level, smaller indices have given good alpha over a 1 year period. However, if you consider the longer run CAGR returns and adjust for higher volatility risk, the large cap indices may be actually doing appreciably well.

THEMES THAT STOOD OUT IN THE LAST 1 YEAR

The analysis of Indian markets is not just about capitalization indices or about sectoral indices. It is also about thematic indices; which are usually a combination of sectors. Let us first look at some of the key thematic indices that have done very well in the last 1 year to March 31, 2024. For FY24, the Central Public Sector Enterprises (CPSEs) as a theme have generated more than 100% returns in last one year. Defence is another theme that has seen a lot of government orders being farmed out resulting in over 100% returns in the last 1 year. Among the other themes that have done well in the last 1 year are energy, mobility, infrastructure, and logistics; all new age themes. What about CAGR returns of themes over a 5-year period? Defence is the star with over 44.72% CAGR returns over last 5 years; with PSUs, energy and infrastructure being the other enduring outperforming themes. Incidentally SME Emerge theme generated 5-year CAGR returns of 49.4%, so it is not surprising that the SEBI is worried about froth in these SME stocks.

HOW SECTORAL INDICES FARED ON RETURNS IN FY24?

The table captures the key sectors and returns generated across different time frames. The table is ranked on 1-year returns to capture the FY24 impact.

Sectoral Index	1-Year Returns	3-Year Returns	5-Year Returns
Nifty Realty	133.40	39.62	27.85
Nifty PSU Bank	89.96	49.76	16.76
Nifty Auto	76.26	30.74	22.18
Nifty Oil & Gas	61.27	24.80	19.08
Nifty Healthcare Index	59.32	18.92	18.67
Nifty Pharma	59.32	16.56	16.16
Nifty Metal	50.78	29.69	24.06
Nifty non-Banks	47.88	15.65	13.59
Nifty Consumer Durables	35.19	15.31	16.39
Nifty IT	23.91	12.67	19.80
Nifty FMCG	19.08	17.73	14.17
Nifty Financial Services	17.41	11.01	11.55
Nifty Bank	17.02	13.02	9.68
Nifty Private Bank	15.09	10.48	6.82
Nifty Media	5.97	5.82	-5.59

Data Source: NSE Indices

The table may look like a melee of numbers, but there are some interesting takeaways.

• On a 1-year basis, the Realty Sector continues to lead at 133.4% returns. Housing demand is robust as is evident in the spike in home registrations and the rapid winding down of inventory. Commercial demand is picking up from GCCs, warehouses, and data centres. Stamp duty exemptions by state governments are boosting the realty story.
• What are the other big gainers and losers on the basis of one-year returns? PSU Banks are an obvious choice with 89.96% returns, but others like Auto at 76.26%, Oil & Gas at 61.27%, Healthcare at 59.32% and metals at 50.78% have done well too. In fact, 9 out of the 16 sectors have delivered better than Nifty returns in FY24. What about the bottom of the heap? Banks are under pressure; and this is largely driven by private banks. HDFC Bank performance and post-merger concerns have been an overhang, while the downgrade of Indian banks by Jefferies has added to the tepidness in banks. FMCG index has been hit by weak rural demand and rising crude prices; while IT took a hit on margin concerns and the recent lowering of revenue guidance by Accenture.
• Does the picture change if you look at 5-year returns? The top performing sector in terms of 5-year returns are Realty, Metals and Autos in that order. Interestingly, IT had also done well over a 5-year period, delivering 19.8% returns CAGR. Private banks have been the laggards over a 5-year period.

FY24 has been about the sectors like realty, autos, oil & gas, and PSU banks; which have been the high momentum stories. The scenario is balanced over a 5-year period.

SECTORAL INDICES AND RISK PARAMETERS FOR FY24?

Analysis of returns is, often, incomplete without a look at risks. Here is a ranking of sector based on 1-year risk parameters.

Sectoral Index	1-Year Volatility	1-Year Beta	1-Year Correlation	1-Year R2
Nifty Media	27.19	1.05	0.38	0.14
Nifty PSU Bank	23.94	1.26	0.52	0.27
Nifty Realty	22.21	1.19	0.53	0.28
Nifty Metal	19.70	1.37	0.68	0.46
Nifty IT	18.71	1.06	0.55	0.31
Nifty Oil & Gas	17.37	1.21	0.68	0.46
Nifty non-Banks	13.96	0.97	0.68	0.46
Nifty Auto	13.36	0.89	0.65	0.42
Nifty Pharma	13.20	0.52	0.38	0.15
Nifty Healthcare Index	13.11	0.54	0.40	0.16
Nifty Private Bank	12.88	1.06	0.80	0.64
Nifty Bank	12.58	1.05	0.81	0.66
Nifty Financial Services	12.08	1.04	0.84	0.70
Nifty Consumer Durables	11.63	0.67	0.56	0.32
Nifty FMCG	11.12	0.64	0.56	0.32

Data Source: NSE Indices

The above table is ranked on 1-year volatility starting with the most volatile sectors and going down to the least volatile sectors.

• In terms of standard deviation of returns, the more aggressive plays during the year like PSU banks, metals and realty were also high on the volatility scale. However, the higher volatility risk was compensated by higher returns. It is in IT that the returns are not commensurate with the underlying risk, at least in the short term. On the low volatility side, you have the standard suspects like FMCG, Consumer Durables and surprisingly, financial services. The stability and low volatility is essentially coming from the insurers.
• What about Beta? Higher the Beta above 1, more aggressive the sector in terms of returns and risk. The high beta sectors in the year were metals, PSU Banks, realty, and oil & gas. That is not surprising since these have scored aggressively in a year when the Nifty has generated returns of over 30%. The low beta sectors were, obviously, healthcare, FMCG, consumer durables. and automobiles.
• Finally, let us look at correlation and R². Correlation shows whether the sector offers diversification benefits versus the Nifty. Lower the correlation, more the diversification benefit. From that perspective, healthcare, consumer durables, and PSU banks offer the best diversification benefits. The R² shows how much of the performance is explained by the index movement. Lower correlation makes the sector a good diversification bet.

PSU banks, in FY24, not only emerged as an interesting high returns play; but also, a good diversification bet for a large cap portfolio.

SECTORAL INDEX VALUATION STACK FOR FY24

Finally, we look at the sectoral valuations stack on P/E, P/BV and on dividend yield to conduct a quick check on overpriced and underpriced sectors.

Sectoral Index	Price/Earnings (P/E Ratio)	Price / Book (P/BV)	Dividend Yield
Nifty Consumer Durables	71.36	10.43	0.39
Nifty Realty	59.04	5.69	0.26
Nifty FMCG	42.27	10.98	1.98
Nifty Healthcare Index	41.53	5.75	0.57
Nifty Pharma	36.57	5.22	0.69
Nifty IT	29.93	7.51	2.03
Nifty Metal	27.22	2.42	2.31
Nifty Auto	25.14	5.54	0.87
Nifty non-Banks	23.13	3.27	0.86
Nifty Financial Services	17.56	3.27	0.82
Nifty Private Bank	16.42	2.68	0.63
Nifty Bank	15.84	2.77	0.78
Nifty PSU Bank	9.57	1.63	1.52
Nifty Oil & Gas	9.38	2.06	2.40
Nifty Media	0.00	1.86	0.40

Data Source: NSE Indices

Here are some of the key takeaways from the three valuation parameters. Let us look at how the sectors stack up on each of these valuation parameters.

• In terms of the P/E ratio; consumer durables, realty, FMCG and healthcare are the most expensive, with P/E ratios in the range of 40X to 70X. While FMCG and consumer durables can justify higher P/E ratio based on brand value, it would be much tougher for the realty companies to explain such premium valuations. Real estate appears to be a case of earnings struggling to keep pace with valuations as a lot of pent-up demand for realty stocks is chasing short supply. On the downside Oil & gas and PSU banks are still available at single digit valuations, so there is still money on the valuation table.
• How do sectors stack up on price to book ratio or the P/BV ratio? In a sense this is an extension of the P/E ratio argument. So, you have sectors like FMCG and consumer goods trading at rather expensive double-digit P/BV. However, this must be taken with pinch of salt as the book value of these companies tends to be low due to the largely intangible assets that these sectors rely on. These are not reflected in the balance sheet and hence tends to overstate the P/BV ratio. Unlike P/E ratio, the P/BV has very specific applications for specific situations and may not add value to all sectors. P/BV works very well for financial services companies; and for long gestation businesses like telecom, internet, and green energy.
• Dividend yield can be defined as the rupee dividend paid out by the company as a ratio of its market cap. Generally, at a sectoral level, the companies with high dividend yield are considered relatively undervalued. The Nifty has a dividend of 1.22%. In terms of sectors, there is oil & gas at 2.40%, metals at 2.31%, IT at 2.03%, and FMCG at 1.98%. Metals are cash cows and high dividend yields make the stock attractive. However, it remains a cyclical play. The real surprise is the FMCG sector and the IT sector; with dividend yields of 1.98% and 2.03% respectively. For both sectors, the higher dividend yield has been part of a conscious corporate strategy.

It would be pertinent to point here that high or low P/E ratio or dividend yield are anecdotal and must not be treated as a forward looking estimate of sector attractiveness. Eventually, the price gravitates towards the right value; although it takes time. Investors would do well to remember John Maynard Kaynes, “Markets can stay irrational for much longer than investors can stay solvent.” That is the challenge.