Kotak Institutional Equities Warns of Overvaluation in Indian Market Despite October Dip—Risks Still Loom

Indian markets saw a significant drop in October after a steady nine-month rally, with foreign portfolio investors (FPIs) pulling out ₹82,479 crore from Indian equities, marking a record outflow. Despite this decline, Kotak Institutional Equities remains cautious, suggesting that Indian stocks are still highly overvalued. The recent correction, which saw both Nifty 50 and Sensex fall by over 4%, hasn’t eased concerns for the brokerage firm. From their peaks, both indices have corrected by nearly 6%, but Kotak points out that valuations across most sectors—except for banks—are still far above their pre-pandemic levels.

The firm has expressed concern over these elevated valuations, noting that they persist despite several worrying factors. Growth rates in many sectors (aside from investment stocks) remain lower than pre-pandemic levels, while the cost of equity, based on India’s 10-year bond yields, remains stable. Additionally, various industries are facing heightened risks of disruption. Kotak emphasized that there hasn’t been a significant market pullback since the COVID-19 pandemic, which makes the situation even more alarming.

“There is no change in our cautious view of the market despite the recent correction in the market (modest in the large-cap stocks and large in certain mid-and small-cap stocks),” the brokerage noted. Kotak also warned that the multiples for most sectors remain at “full-to-frothy” valuations, with very few stocks offering genuine value. It highlighted that these high valuations are driven by unrealistic growth and profitability assumptions, which often stem from inflated stock prices. Moreover, the brokerage explained that relative valuations become meaningless when all stocks within a sector are trading at inflated levels.

Kotak also raised the issue of how long retail investors will continue to ignore prices and valuations and keep buying stocks at all levels. “The recent sharp correction in some of the ‘narrative’ sectors and stocks may have brought a much-needed dose of realism to a section of investors. However, the overall market sentiment is still quite euphoric,” it said.

2QFY25 Results: A Slowdown Across Sectors

Kotak Institutional Equities analyzed the Q2FY25 results and found signs of a broad-based slowdown in the Indian economy. Many companies underperformed against modest expectations for net sales, EBITDA, and net profits. Consumer companies posted weak results, with their commentary indicating a difficult demand environment. IT companies delivered unexciting results and signaled a gradual recovery, while banks performed relatively well with moderate credit growth and stable net interest margins (NIMs) and asset quality on a quarter-on-quarter basis.

One of the key challenges highlighted by the brokerage is that companies’ continuous price increases are squeezing household affordability, intensifying competition from unorganized players. Retailers like DMart and Reliance Retail reported muted numbers due to stiff competition from newer market entrants. The unexpected success of brands like Zudio and Trent in the apparel sector, along with the rise of quick commerce in household products, reflects the growing risk of disruption for established players.

The report further stated that consumer-facing companies are struggling to maintain their elevated profit margins, with both automobile and consumer goods companies experiencing margin compression and volume challenges. Over the last 3-5 years, these companies have significantly raised prices, pushing many consumers to cheaper alternatives. This trend of “downtrading” has allowed regional players to fill the gap left by these higher price points.

Kotak Institutional Equities remains cautious, pointing to significant downside risks related to the lofty profitability assumptions for these companies. The brokerage’s analysis suggests that the elevated valuations and weak market fundamentals pose considerable challenges to investors, especially in consumer-facing sectors that have seen sharp price hikes but now face affordability concerns among consumers.