The mojo of PSU bank stocks might fade away soon. Here’s why


PSU banks have been in focus for quite some time due to several tailwinds, as most entities are performing well both internally & externally from maintaining healthy asset quality to several governments’ initiatives where PSU banks are the beneficiaries.

The PSU Bank Index has risen by more than 56% in the last 1 year, the Nifty Private Bank Index rose by just 14%, and in the same period Bank Nifty by 13%, making PSU Banks the leader of the segment.

The government kickstarted the rally through banking reforms such as the establishment of Bad Banks to move the long outstanding NPAs out of the books, the implementation of the Insolvency & Bankruptcy Code helping banks to recover their debts and, merger of several PSU banks enabling them to have a more focused approach on their operations.

The current government’s focus on long-term projects of infrastructure, power, and agriculture would benefit PSU banks more than private banks as they traditionally have higher exposure in these sectors. This is one of the factors due to which the share prices are soaring to new highs.

But do they have enough fuel to move further up? I believe not. Here’s why I think so…

PSU Banks usually trade at a low Price-to-Book value but currently, they are trading at the highest levels compared to their historical valuations. The valuations look stretched. Share price appreciation happens because of two main reasons: Earnings expansion and perception-led growth or multiple expansion. The former can be computed based on financials on a quarterly and yearly basis and the latter could be assumed as the difference between share price CAGR and earnings growth CAGR. The lower the difference, the higher the safety and vice-versa. The current rally in several PSU Banks is more because of multiple expansions rather than earnings expansion. Further, the government holds more than 90% shares in several PSU banks. This concentrated holding creates a supply-demand mismatch that propels the share price upwards. The change in perceptions and low float resulted in a gigantic rally in PSU banks recently.

On the other hand, few Private Banks with good prospects are trading at reasonable valuations compared to PSU banks. Many of the mammoths are trading near or lower than their average price-to-book value. Making it a much more attractive and safe investment to bet upon.

That’s not all, the price action of Private Banks also indicates that the underperformance spree might be ending soon. Here’s a ratio chart illustrating the underperformance of private banks over PSU banks. A falling line means Private banks are underperforming PSU banks. You will notice that the line has been falling since 2021. The line is now touching support levels last seen in 2018. The momentum indicator RSI also suggests slowing momentum.

Agencies

That’s not all, ratio chart of the Nifty Private Bank Index to the Nifty Index also provides similar insights at current levels. The line is touching the previous resistance-turned support along with RSI hitting oversold zones.

Bank chart 2Agencies

Thus, both charts suggest that private banks are at their lowest and are in an oversold zone from where the reversals had started in the past.

Given the present lofty valuations in the PSU Banks, perceptions led- momentum and based on the price action of private banks it would be prudent to add private banks to the portfolio. Investors stand to benefit by pivoting towards private banks with potential and avoiding PSU banks which are overvalued.

Technical Outlook:

Bank chart 3Agencies

In a weekly wrap, the Nifty slipped lower by 0.33% and ended at 21,783.

The Major support came from Nifty PSU Bank and Pharma with 5.07 % and 3.59 % respectively on the flip side, Nifty FMCG ended on the lower side by 2.27 %.

Throughout the entire week, the Nifty persistently attempted to break the critical resistance threshold of 22,000 yet each attempt turned into a sell-off.

Last week the Nifty broadly consolidated in the 21,600–22,000 range. The weekly support remains around the 21,330 zone with resistance positioned at the all-time highs of 21,127 levels. Despite the weekly candlestick, it continues to portray a bearish trend as it remains in the red.

In the previous week, Foreign Portfolio Investors (FIIs) maintained their stance and continued as sellers amounting to Rs 6,013 crore. Meanwhile, Domestic Institutional Investors (DIIs) were buyers, accumulating Rs 5,748 crore until Thursday.

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