PSU Stocks: Will the Party Continue in 2024 

Hello everyone, Rahul Shah here, trying to make investing accessible and profitable for the average investor.

For a very long time, I was of the view that stock market investing is all about finding the big winners. It is about finding the next big multibagger and riding it to the top.

However, slowly, and steadily I realised there's another equally successful way of investing.

Stock market investing isn't just about finding the big winners. It is also about avoiding the big losers.

A lot of the super successful investors don't think too much about the upside. They are all about minimising the downside.

They stay away from toxic stocks i.e. stocks with poor fundamentals or extremely high valuations or both.

The man who played a big role in making me aware of this strategy was none other than Benjamin Graham.

A great example of this is Ben Graham's testimony on the stock market before the Committee on Banking and Currency back in 1955.

Ben Graham was asked by the Chairman of the Committee how he knew that a stock he bought at 10 will eventually go up and reach what Graham thinks to be its fair value of 30.

How this move from 10 to 30 happens is what the Chairman wanted to know.

Graham's answer taught me the lesson that I just highlighted.

Graham opined that this was one of the mysteries of the investment business. It is a mystery to him as well as to everybody else.

He further opined that he knows from experience that eventually, the market catches up with value. It realises it in one way or the other.

Graham's replies gave me a fresh perspective with which to look at stocks. As I said earlier, finding the next stock market winner or the next big multibagger is not the only road to riches.

Focusing more on buying hated stocks where the margin of safety is big and where the business quality is decent, if not the best, is also a good way to earn market beating long term returns.

But what makes me confident that these hated stocks will eventually become popular and end up giving good returns?

Well, as Graham said, how the price catches up with value is a mystery of this business. But given how stock market has worked in the past, the price does catch up with value more often than not.

Who would know this better than investors who invested in PSU stocks a year or two ago.

I clearly remember that a lot of investors, even the most successful ones, didn't want to come anywhere close to PSU stocks. The fact that these were decent businesses and were available at extremely attractive valuations, didn't register with them.

They kept waiting for some catalyst to take the price higher. And even if the catalysts did come in the form of huge government spending on defence and infrastructure, which boosted the profits of these stocks, old biases were hard to shake off. A lot of the investors still stayed on the sidelines.

On the other hand, taking a simpler approach of buying good quality undervalued stocks at extremely attractive valuation and then waiting for 2-3 years for the price to catch up with value, would have yielded handsome results.

A portfolio of the most undervalued stocks in India with decent management and strong balance sheets would have led you to a lot of PSU stocks and investing in them would have worked like magic.

For perspective, the S&P BSE PSU index, has given an impressive 44% returns this year. This is 3x as high as the returns earned by the Sensex.

Of course, individual stocks have done even better, with some of them earning multibagger returns in a matter of 1-2 years.

So, PSU stocks have given fantastic returns and a lot of investors have missed this bus. But what next? Can these investors still come aboard?

Can these PSU multibaggers continue their good run well into 2024? Or is it too late now and the risk reward is no longer in favour of the investors?

Well, I did some research and the findings are not very encouraging. Out of 64 PSU stocks that I have data for going back many years (excluding PSU banks), nearly 8 out of 10 PSU stocks are trading above, and only 2 are trading below, their historical valuations.

Further, only 1 out of 10 PSU stocks is trading at least 25% lower than its historical valuation.

In fact, here are the top 10 stocks that are trading at the biggest premium to their 10-year average price to book value multiple.

The first one i.e. The Fertilisers And Chemicals Travancore Ltd (FACT), is a bit of an outlier, trading at 11x the multiple it has traded in the past.

Now, the reason I took price to book value and not price to earnings as a valuation indicator is because I found it more reliable than the PE ratio as earnings were quite volatile for some of the companies.

After FACT, you have rail, defense, mining, and power stocks that are also way higher than their long term PBV multiples. Clearly, the sentiments around these stocks have changed and changed big time.

Now, here's the list of 10 stocks that are most undervalued i.e. trading lower than their historical PBV ratios.

There are some stocks here where the risk reward still looks attractive and then there are others like MMTC, where the historical performance doesn't inspire a lot of confidence and where valuing the stock doesn't look like an easy job.

So, what's the final verdict? Well, while I can't give you explicit buy and sell recommendations here, I can certainly try and guide you in the right direction.

You see, stocks ask different questions at different valuations.

When PSU stocks were trading extremely cheap, all you had to ask was whether these businesses will survive and whether they will continue to grow at the same rate as in the past if not faster?

If your answers to both these questions were yes then all you had to do was invest and wait for the market to realise the true value of these stocks.

At current valuations though, there is an entirely different set of questions that you need to ask if you want to make money from these stocks.

These questions would be:

Can the government continue with its huge capex plans? Do these stocks have the balance sheet and the management bandwidth to grow at a much faster rate in the future? Will the market continue to award premium valuations to these stock?

If you think you will need to do quite a bit of research and understand these stock more deeply to answer these questions, then you can hold on to the ones trading at premium valuations and do your research.

But if you believe finding reliable answers to these questions is beyond you, then perhaps it is a good time to exit them.

All in all, you need to be honest and figure out which of these buckets you fall into. There are some PSU stocks, especially among the ones that are still priced as value stocks, where the first set of questions might suffice.

And then there is the second group of stocks trading at expensive valuations where you may need to answer the second set of questions.

Another way of looking at this is what kind of an investor am I? If you ask this question to me, I will have no hesitation in saying that I am a deep value or a value investor where I like to buy stocks cheap make my 50%-100% profits in 2-3 years and move on.

I am not a growth at reasonable price or a growth investor where I have to pay high PE multiples up front and then wait for the earnings growth to materialise. I don't' like playing the growth game.

I believe the growth investing field is too competitive and have too many participants. Thus, with most PSU stocks no longer being deep value or value stocks, it may not attract the interest of investors like me. This is perhaps the time for growth investors to start looking at PSU stocks.

And you may not necessarily copy me. Your decision will depend on the approach you want to take.

So, think carefully and only then take an appropriate call.

Happy Investing.