Strong earnings key to sustain premium valuation of capital goods stocks

But to maintain these valuations, a number of factors, including their financial earnings performance, have to be factored in. The Motilal Oswal report, published earlier this month, said key monitorables for the sector include inflow of orders into companies, increased execution levels in critical projects, improving liquidity position and spending by the central government. Otherwise, the valuation premium may not last long.

The broking house highlights that the sector has seen several business cycles, and has followed valuation multiples. In FY10-14, the valuation premium (30% premium over Nifty) for the sector came down due to policy paralysis. After the general elections in FY14, the valuation premium expanded in anticipation of the capex cycle recovery during FY14-16, the valuation premium for companies in this sector was 111 for Nifty and Sensex PE in FY11-14, respectively. % and increased to 30% premium. , in anticipation of a resurgence in capex activity, which failed to materialise, it said.

“After FY16, the average premium of Nifty P/E has narrowed to 49.4% due to (a) lower-than-expected growth in the pace of capex activity and (b) fears of further slowing of activity due to CY19 general elections. . As of October 2021, the sector’s premium relative to Nifty stood at around 39%, lower than the long-term average of 42%,” the report said.

The September quarter earnings for the sector showed improvement in order inflows and execution, though analysts say a full recovery in earnings may take a few more quarters.