Sectoral index story on risk, returns and valuations for December 2023

5 Jan 2024 , 02:28 PM

NSE released the index wise performance for its key sectoral, generic, and strategy indices for December 2023. This data goes much beyond returns; and also includes the risk factors (measured by volatility) and valuation factors (measured by P/E, P/BV, and dividend yields). While generic indices are also available, they become too diverse in terms of composition. Also, the comparison of a small cap index and a large cap index may not give too much insights on a risk-returns basis. Strategy indices, on the other hand, differ widely in terms of risk; and often leverage risk for higher returns. The sectoral indices on the NSE are more comparable as they offer a unique way to look at the performance of sectors through the lens of various sector indices. This monthly report by the NSE, gives a good basis to rank sectors on return, risk, and valuation parameters.

What we read from the December sectoral sheet?

The sectoral rankings as of the end of December 2023 offers some interesting insights into the pecking order in terms of returns, risk, and valuations. There are some quick inferences we can draw from the numbers. On a return basis, the realty sector, autos, healthcare, and the PSU banks have been among the leaders. That is not surprising considering that most of the short term momentum in 2023 was concentrated in them.

In terms of risk, the traditional defensive sectors continue to score low on risk. So, FMCG, consumer goods and healthcare have been low on risk on all counts. However, they have also been high on the valuation metrics (P/E ratio) as they are not just valued on earnings but also intangibles like brands, marketing network, entry barriers etc. One surprising factor that emerges is how IT sector has become a cash cow with top class dividend yields.

Why this sectoral view is important?

Indian market has been more a growth market and less a value market. While pockets of value do emerge occasionally, it is the growth story that is in sync with the economy moving from being a $3.5 trillion economy to a $5.0 trillion economy over next 7 years. How do you catch growth stories? Obviously, you must start with the growth sectors. While a longer term return picture gives you a sense of value creation or wealth creation, it is the shorter term returns that gives you the best picture of momentum.

If you look for strong momentum in the year 2023, it would be sub-sectors like EPC within capital goods, AI stocks within IT, defence stocks within heavy industries, EV players within automobiles etc. Such trends are best visible if you look at the sectoral returns. However, returns are just an indicator of where you should look at. The investment decision has to be tempered by risk factors and valuation factors. The risk and valuation factors would tell you how to circumscribe the return data with necessary safeguards. Here we look at the sectoral index performance as of December 2023, across returns, risk, and valuation parameters.

How sectoral indices fared on returns as of December 2023?

The table captures the key sectors and returns generated across different time frames. The table is ranked on 1-year CAGR returns to capture the momentum story best.

Sectoral  Index	1-Year  Returns	3-Year  Returns	5-Year  Returns
Nifty Realty	82.02	36.06	28.03
Nifty Auto	48.75	27.80	16.42
Nifty Pharma	34.76	10.08	14.53
Nifty Healthcare	33.99	12.77	16.33
Nifty PSU Bank	33.28	49.95	13.86
Nifty Non-Banks	32.86	15.74	14.08
Nifty FMCG	30.78	20.84	15.17
Nifty IT	26.30	15.70	22.13
Nifty Consumer	23.69	16.55	18.71
Nifty Media	20.29	13.89	-0.60
Nifty Metal	19.12	37.31	22.54
Nifty Private Bank	14.63	13.61	10.71
Nifty Financial Services	14.31	13.10	13.87
Nifty Bank	13.29	16.37	12.75
Nifty Oil & Gas	13.10	21.93	17.80

Data Source: NSE Indices

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

• On a 1-year basis, capturing the momentum of these sectors, it is the Realty Sector at 82.02% that stands out as the pick of the sectors. The reasons are not hard to seek. With housing demand picking up and commercial property demand picking up across select sectors, the demand in most of the major cities is at an all-time high. Special incentives by the state government in the form of stamp duty concessions have also helped boost the sector. RERA has surely made the sector more predictable. Auto, healthcare and PSU banks were among the other top performing sectors.

   

• Which are the sectors that ended at the bottom of the heap in terms of 1-year returns. Obviously, the oil & gas sector is at the bottom, despite the late recovery in the last quarter. In the absence of the recovery, the returns would have been flat or negative. Private banks did not perform too well due to valuation concerns and HDFC Bank proved to be the overhang post the merger with HDFC Ltd. Even metal stocks were subdued on the back of weak demand cues from China.

   

• Does the picture change if you look at 5-year returns? The top performing sector in terms of 5-year returns is still the realty sector. However, metals and IT also come at the top. IT has been one of the top performers, except in the latest year when growth and margin concerns came back to haunt the sector. Metals rode the commodity cycle in the last few years. At the bottom of the heap was media, largely due to the predominance of Zee Entertainment. Other than media, most of the financials were at the bottom of the heap in terms of five-year returns.

The 5-year returns are along expected lines, but it is the 1-year momentum data that throws up some interesting surprises.

How sectoral indices fared on risk parameters in December 2023?

Returns are just one part of the story; the other side is risk. Here we look at risk in terms of three main parameters viz. volatility, Beta, and the correlation with the index.

Sectoral  Index	1-Year  Volatility	1-Year  Beta	1-Year  Correlation
Nifty PSU Bank	25.02	1.44	0.56
Nifty Media	21.86	0.87	0.39
Nifty Metal	21.11	1.38	0.64
Nifty Realty	20.11	1.07	0.52
Nifty IT	17.78	1.13	0.62
Nifty Oil & Gas	15.35	1.03	0.66
Nifty Non-Banks	13.39	0.99	0.72
Nifty Bank	12.68	1.10	0.85
Nifty Auto	12.61	0.75	0.58
Nifty Private Bank	12.60	1.09	0.84
Nifty Healthcare	12.06	0.50	0.41
Nifty Financial Services	12.05	1.07	0.87
Nifty Pharma	11.97	0.46	0.37
Nifty Consumer	10.85	0.56	0.51
Nifty FMCG	10.67	0.52	0.48

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 are at the top. In all these cases, the returns have come at the cost of higher volatility. At the other end you have FMCG, healthcare and consumer goods, where the volatility has been traditionally low, due to stable business models.

   

• Let us turn to Beta. Higher the Beta above 1, more aggressive the sector in terms of returns and risk. The high beta sectors in the year were PSU banks, metals, and IT. While IT is surprising, PSU Banks and metals have also been among the most volatile. In the case of PSU banks, the volatility has resulted in higher returns. However, in case of metals, since the risk is external, high beta has not resulted in higher returns. Like  on volatility rankings, FMCG, healthcare and consumer goods rank at bottom on Beta too.

   

• We finally look at correlation; how much of the returns are explained by index returns. The correlation is the highest for the financials, which means most of the returns can be explained by the index movement. That is logical as financials have a 36% weight in the index. Healthcare and FMCG are among the low correlation play, which means they were good defensive additions to the portfolio. 

There were not too many surprises in terms of low risk plays. However, among the higher risk plays, PSU banks did gain from higher risk, but metals did not exactly do so.

How sectoral indices stacked up on valuation parameters in December 2023

Finally, we look at how sectoral indices stack up on valuations. We not only look at P/E and P/BV, but also at dividend yields; which is a better barometer of sectoral valuations.

Sectoral Index	Price/Earnings  (P/E Ratio)	Price / Book  (P/BV)	Dividend  Yield
Nifty Consumer	68.63	9.83	0.44
Nifty Realty	50.39	4.98	0.28
Nifty FMCG	45.81	11.81	1.79
Nifty Healthcare	38.86	5.08	0.63
Nifty Pharma	33.91	4.59	0.78
Nifty Metal	33.65	2.34	2.74
Nifty IT	29.74	7.71	2.33
Nifty Auto	26.33	5.33	0.90
Nifty Non-Banks	20.34	3.59	1.01
Nifty Financial Services	18.63	3.36	0.78
Nifty Private Bank	18.45	2.86	0.60
Nifty Bank	16.60	2.81	0.76
Nifty Oil & Gas	8.20	1.71	2.66
Nifty PSU Bank	8.11	1.32	1.86
Nifty Media	N.A.	2.55	0.41

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 goods, realty, FMCG and pharma are among the most expensive. The higher P/E ratio for consumer goods and FMCG is understandable as they have strong brands and leverage these brands to get better valuation in the market. The intangibles are quite strong in this case. However, in the case of realty, there may be a concern that the returns have come at a much higher valuation, so the risk also increases proportionately for the investor. Oil & gas and PSU banks are still available at single digit valuations, but that is because valuations have not kept pace with earnings growth. That is due to regulatory uncertainty surrounding these stocks.

   

• How do the sectors stack up in terms of the price to book ratio. In a sense this is an extension of the P/E ratio argument. So, you have sectors like FMCG, consumer goods, IT and autos that have the highest ratio of P/BV. The first three are understandable, but in the case of autos, the market valuations have gone up much faster than the pace of asset creation. You again have oil & gas and PSU banks at the lower end. A word of caution where. P/BV is not the ratio that can be applied to all sectors. However, in case of loss making sectors or in case of financial sector companies, the Price / Book ratio does offer useful insights into the working of the sector.

   

• Let us finally look at dividend yields. This is the rupee dividend declared by the company as a ratio of its market cap. Generally, at a sectoral level, the companies that report high dividend yield are considered to be relatively undervalued. The Nifty has a dividend of 1.28%. In terms of sectors, there is metals at 2.74%, oil & gas at 2.66% and IT at 2.33%. In the case of metals, these are cash cows and high dividends are one way of making the stock attractive. For oil & gas companies, PSUs have been asked to pay out higher dividends by the government. The real surprise is the IT sector which has substantially improved its dividend yield over last few years. At the lower end you have consumer goods and realty, but that is more on account of steep valuations.

One final note here! Just because a stock is underpriced or overpriced, it does not mean the price should gravitate towards the mean in the short term. However, over the long term, these ratios do tend to gravitate towards the historic average. But in the short term, the markets can remain more irrational than you can imagine!