The stock market’s recent weakness has left investors facing a difficult choice: companies delivering strong earnings growth often command expensive valuations, while stocks that appear cheap may lack the growth needed to justify an investment. Samit Vartak, Founder and Chief Investment Officer of SageOne Investment, believes investors need to be selective rather than chase momentum or buy stocks simply because they have become cheaper.
Friday’s rally helped the Nifty and the Sensex snap an eight-week losing streak, with both indices gaining nearly a percentage point. FMCG stocks and PSU banks led the gains, while metals lost their sheen. But Vartak believes the broader market remains expensive despite its relatively subdued returns over recent years.
The tricky situation is that even though the markets haven’t delivered much in terms of returns over the last 2.5-3 years, and probably over the last 4 years in dollar terms, the broader market still isn’t cheap.SAMIT VARTAK, FOUNDER AND CIO OF SAGEONE INVESTMENT
Why investors need to avoid both expensive growth stocks and value traps
Vartak sees two potential pitfalls in the current market. Companies with strong earnings growth momentum tend to command high valuations, while businesses with little or no growth can trade at low multiples. Buying the former after a strong rally can expose investors to a correction, while buying the latter in anticipation of a recovery can leave them stuck in stocks whose earnings never improve.
He prefers businesses with a long-term structural growth story rather than those benefiting from short-lived market momentum. That requires examining individual companies instead of assuming an entire sector is attractive because it is popular or has become cheaper.
It’s a very bottom-up stock-picking market today, as it always is, of course. But today, one has to be extremely careful about investing on either the momentum or the value side because one can get stuck in either.SAMIT VARTAK, FOUNDER AND CIO OF SAGEONE INVESTMENT
Defence stocks: Why the business model matters as much as the sector
Defence illustrates why investors need to look beyond a sector’s growth prospects. Vartak pointed out that some of the larger listed defence companies trade at price-to-earnings (P/E) multiples of 80–90 times, while certain smaller or pre-IPO companies in similar areas are available at 15–20 times earnings.
However, a lower valuation does not automatically make a company a better investment. The nature of its business, the predictability of demand and the length of its product cycle also matter.
Submarine manufacturers, for instance, depend on large capital expenditure programmes and long project cycles. A submarine may have a life of 40 years, making it difficult to predict when the next spending cycle will begin. If capital expenditure dries up while an investor still holds the stock, the share price could fall sharply. Vartak said some such companies have seen their P/E multiples decline to 10, 12 or 15 times.
He prefers to be more conservative about valuations for businesses dependent on long investment cycles. Products such as ammunition, which are used regularly, present a different demand profile.
“I would rather be very conservative about the entry valuation and look for something in defence that is more consumable and used every year,” he said.
The distinction explains why Vartak assesses risks at the individual business level, even when companies operate in the same sector.
Why Vartak is staying away from IT stocks
Vartak’s reluctance to invest in information technology companies reflects his earnings-growth requirements and concerns about predictability.
He said his strategy generally requires earnings growth of at least 20%. Most IT companies fall short of that threshold, while those delivering stronger growth tend to trade at valuations beyond his comfort zone.
He is also reluctant to rely on a future re-rating of valuation multiples to generate returns. Investors may buy a cheap stock expecting the market to recognise its value eventually, but it is difficult to predict when that will happen.
Artificial intelligence adds another layer of uncertainty. Vartak noted that some IT companies are acquiring businesses in the AI space, but investors outside those companies may find it difficult to assess how the acquisitions will be integrated or whether they will add value.
“It’s very difficult to predict how those acquisitions will play out,” he said.
As a result, Vartak said the funds he manages do not have exposure to IT companies, including those reporting growth, because their valuations remain outside his comfort zone.
Why some large-cap NBFCs appeal to him
Although Vartak focuses mainly on mid-cap and small-cap companies, he sees opportunities among some large non-banking financial companies (NBFCs).
He said certain larger NBFCs that previously traded at P/E multiples of eight or nine times have fallen to around 4–4.5 times. Their return on assets (ROA), however, remains above 4%.
Vartak considers this combination attractive, particularly because these businesses also fit his requirement for earnings growth of 20% or more. He believes they could attract more capital and potentially see their valuations improve when foreign institutional investor (FII) money returns to large-cap stocks.
What SageOne’s portfolio valuations reveal
Vartak outlined the earnings-growth expectations and valuations of two portfolios managed by SageOne to explain why he looks beyond the largest listed companies.
The firm’s core portfolio focuses on mid-cap and small-cap companies with a minimum market capitalisation of ₹10,000 crore. It primarily covers companies within the top 500 but outside the top 100.
Vartak said the portfolio’s expected earnings growth over the next two years is around 30%, while its next-year P/E multiple is approximately 29–30 times. He described this as a price/earnings-to-growth (PEG) ratio of around one.
SageOne’s alternative investment fund (AIF) has a broader investment universe, extending from mid-caps to micro-caps and including some small and medium enterprise (SME) stocks. It also participates in pre-IPO investments.
According to Vartak, the AIF’s expected earnings growth is close to 40%, against a next-year P/E multiple of around 20 times, giving it a PEG ratio of approximately 0.5. He added that pre-IPO and anchor-book investments had been made at earnings multiples of 10–15 times.
Vartak said the Nifty trades at around 17–17.5 times earnings, but argued that the headline multiple does not tell the whole story. In his assessment, banks and public sector undertakings (PSUs) trade at around 10–11 times earnings, while the rest of the market is closer to 30 times.
SageOne’s portfolios do not hold banks or PSUs, so he believes comparing them with the broader market excluding these businesses provides a more relevant valuation benchmark.
He also sees potential opportunities in initial public offerings (IPOs) when companies with attractive prospects come to market at reasonable valuations. SageOne’s AIFs participate in pre-IPO investments, anchor books, rights issues and preferential issues.
Why SageOne is shifting towards export-oriented businesses
Vartak said SageOne has reduced its allocation to domestically focused manufacturing and increased its exposure to export-oriented manufacturing.
Oleochemicals is one area attracting investment. He said a company the fund is buying has recently completed an expansion and is planning to expand in the US. Its valuation had not moved much despite the rupee’s depreciation, creating an opportunity for SageOne to enter the stock. He declined to name the company because the fund was still buying shares.
The fund has also increased its allocation to a couple of specialty pharmaceutical companies. Vartak cited the rupee’s depreciation and the specialised nature of their businesses as reasons for the interest, adding that these companies face a lower risk of tariffs being imposed on them.
He said many companies in these areas trade at forward earnings multiples of around 20–25 times, which he considers attractive given their expected earnings growth of well above 20%.