BAAP, PAAP & SAAP: PSU, smallcap shares raise valuations concerns. Here’s why

Buy growth stocks at any valuations was quite a fad sometime ago when both earnings and quality were scarce. But with the broader market delivering on earnings front, that ‘quality’ premium got shrunk and ‘quality’ stocks underperformed key indices for an extended period, giving a blow to ‘Buy at any price’ or BAAP theme.

Value theme emerged in no time.

Investors started chasing out-of-favour PSU stocks sometime in 2020; smallcap too found strong support around same time, as domestic money flocked to new themes. Now with many PSUs turning multibaggers and smallcap valuations looking rich, there are concerns over whether high valuations would sustain.

In a light-hearted post on X (formally Twitter), Samir Arora of Helios Capital coined PAAP for ‘PSUs at any cost’ and SAAP ‘Smallcaps at any cost’, suggesting how themes — and investor perception, changed on Dalal Street over time.

In a strategy note, Kotak Institutional Equities said its analysis of PSU stocks suggests that their outperformance may have been driven by a combination of improved fundamentals in a few cases, strong narratives in many cases and possibly low free-float in several cases.

“The very high delivery volume-to-free-float ratio in many PSU stocks shows extremely high churn. Lastly, PSUs with low free floats have on average outperformed those with higher free floats by a significant margin,” it said.

Kotak was quick to note that a large number of the PSU outperformers have seen little-to-no upgrades to their FY25/26 EPS estimates.

“Further, the few cases of earnings upgrades stem from non-sustainable factors, such as benign government policy on pricing of retail automotive fuels in the case of the downstream oil PSUs. We are not sure if these PSUs will see meaningful earnings upgrades over the coming 12-24 months, which can justify the sharp run-up in their stock prices over the past six months,” Kotak said.

Bernstein said it finds only limited opportunities within PSU portfolio – the ones which are high momentum or dividend yielding stocks with reasonable valuations.

“However, we would argue against chasing high volume PSU stocks or the ones which are simply value,” it said in a strategy note.

On smallcap stocks, Prabhudas Lilladher said the BSE Smallcap and the BSE Midcap index have moved up 62 per cent and 64 per cent, respectively, in the last 12 months, which are 2.3-3.3 times higher than returns by Sensex, Nifty and BSE 100 returns.

“The return differential between BSE small/ Mid cap with Sensex/Nifty has been 10-12 per cent raising concerns on stretched valuations in small/mid-caps,” PL said.