Kotak Sounds Alarm: Valuation Disconnect Plagues Indian Markets Despite Two Years of Flat Returns

Kotak Sounds Alarm: Valuation Disconnect Plagues Indian Markets Despite Two Years of Flat Returns​

The state of the Indian equity market has been characterized by a significant divergence between underlying business fundamentals and prevailing valuations, according to the latest strategic assessment from Kotak Institutional Equities. The brokerage asserts that for the past two years, the market has delivered virtually zero returns. This lackluster performance is being driven primarily by elevated valuations relative to both earnings and overall business quality, rather than concerns surrounding Artificial Intelligence (AI) or geopolitical instability.

Kotak notes that external capital dependence and technological reliance present structural challenges to the Indian economy. The report suggests that current optimism on corporate earnings has led to overly generous valuations across many sectors. This widening gap is being exacerbated by large earnings downgrades expected during the second half of FY25 and the first half of FY26, coupled with weakening business models in some areas.

Valuation Gap Persists Across Sectors Amid IT Slowdown​

While a prolonged period of market correction has taken place, Kotak observes that the disconnect between fundamentals and valuations remains widespread. The sharp decline in the capitalization of IT services companies represents one key area affected by this trend.

Meanwhile, private banking and consumer staples sectors have largely remained range-bound despite the overall volatility. However, valuations across several segments are particularly susceptible to correction, specifically naming large-cap NBFCs, insurance, IT services, and private banks. Investor behavior remains a point of interest for the brokerage. Retail investors continue to engage heavily through both Systematic Investment Plans (SIPs) and lump sum investments despite weak returns over two to three years.

Global Caution Limits Foreign Inflows While Domestic Flows Continue​

Foreign portfolio investors are noted to be cautious regarding current valuations and business fundamentals in India. This caution is partly attributed to the fact that AI-related investment opportunities in international markets have reduced the appeal of India for overseas capital flows.

Despite this, domestic institutional investors continue channeling retail inflows into equities. However, Kotak cautions that the return on three-year SIPs remains below that offered by fixed deposits, highlighting the risk inherent in the market's current state. The brokerage maintains a cautious stance on valuations while advocating support for companies boasting strong underlying business fundamentals.

Portfolio Adjustments Reveal Focus on Resilience and Domestic Growth​

Kotak has made specific adjustments to its model portfolios, maintaining a focused approach on businesses that exhibit robust fundamental strength. Hindalco Industries was added to the large-cap portfolio after correcting 18 percent over the last month following declines in aluminium prices. The brokerage expects the global aluminium industry to maintain a tight supply-demand balance over the next two to three years, noting the stock trades at 5.7 times FY2028 estimated EBITDA.

The brokerage also made targeted changes within its mid-cap allocation. Jubilant FoodWorks has been replaced by Jubilant Ingrevia due to stronger growth prospects in the domestic manufacturing segment through CDMO. Kotak projects that Jubilant Ingrevia's revenue, EBITDA, and earnings per share will grow at 18 percent, 24 percent, and 31 percent, respectively, over FY2026-29.

Sectoral Outlook: Favoring Financials and Domestic Services​

Kotak continues to favor sectors demonstrating strong domestic linkages and stable growth paths. This includes financials, healthcare, retail, telecommunications, and hospitality. The allocation to HDFC Bank has been increased, while exposure to Cipla and IndiGo was reduced following their substantial gains.

Conversely, the brokerage remains underweight on consumption and investment-related sectors owing to elevated valuations and moderate anticipated growth prospects. Kotak maintains a positive medium-term outlook for domestic manufacturing segments like capital goods, chemicals, CDMO, electronics manufacturing services, and industrials. However, the report reiterates that valuations will remain the crucial deciding factor in future stock selection and portfolio construction.