PSU stocks tumble from all-time highs – is it time to reconsider or is it an investment opportunity?

While PSU stocks shave had their share of struggles, their fundamentals have seen a major transformation. Once bogged down by balance sheet stress and sluggish growth, many government-owned companies now stand on a firmer footing, market participants said.

The broader view? The fall isn’t a setback—it’s a window for investors to accumulate quality stocks with long-term growth potential.

What does the drop mean?

Ranju Rajan, head of managed accounts at Axis Securities PMS, said there is a potential opportunity in select PSU stocks from a valuation perspective. He backed up his point with a key data nugget.

As of 31 January, 14 of the top 500 companies were near their 52-week highs, down from 141 in September. Meanwhile, 73% of the stocks were more than 20% below their highs, with 42% having fallen more than 30%.

This signals broad profit booking, though large caps remain attractive for long-term investors. Among 55 PSU stocks, none is near its high, a sharp drop from 35 in February 2024, Rajan pointed out.

A slower-than-expected financial performance and high valuations led to profit booking in PSUs, causing the Nifty PSE Index to decline by 26% from its August 2024 peak, said Vinit Bolinjkar, head of research at Ventura Securities.

No surprise

“At its peak, the index traded at 13 times P/E, significantly above its long-term average of 10x. Following the correction, valuations have normalized to 10.7x CY25 P/E, close to historical levels,” he explained.

The Nifty PSE Index comprises 20 stocks in which 51% of the company’s outstanding share capital is held by the Central government and/or state governments, directly or indirectly.

Several significantly undervalued PSU stocks in sectors such as defence and railways had grown at a rapid pace, with high capital efficiency and large multi-year order books, said Vikas Gupta, smallcase manager and CEO at Omniscience Capital.

“Naturally, these went from single digit PEs to 40s and 50s, resulting in 5-10x in price,” Gupta said.

The current order books for these companies are extremely strong, and the budget continues to provide more allocations. Keeping that in mind, the outlook for these companies is bright. At the same time, many of these stocks had become quite overvalued and it was no surprise that they fell, Gupta said.

Alok Agarwal, head of quant and fund manager at Alchemy Capital Management, said, “These stocks are more of a capex play than a consumption-driven bet.”

While the ongoing capex consolidation may temper near-term growth, he said the long-term outlook remains strong. He also emphasized that the government’s commitment to defence, railways and power is notably strong. Most of the key companies in these sectors are PSUs.

He views the decline in PSU stocks as an overreaction to slightly slower capex growth in budgets, even though capex-to-GDP remains at multi-year highs.

Some PSUs rallied with strong fundamentals and low valuations, but many just rode the wave on sentiment. They lacked strong fundamentals, robust growth, and capital efficiency, with profitability remaining weak and future prospects uncertain.

Many were cyclical in nature, yet the market chased them. It is no surprise that these stocks have fallen, and according to some market participants, rightfully so. This only reinforces the clear divide between high-quality and weaker PSUs.

Promising bets

Gupta of Omniscience Capital advises investors to keep an eye on high-quality PSUs and consider adding them when valuations become appropriate. However, he cautions against touching the weaker ones.

Rajan of Axis Securities PMS is of the view that selecting value stocks from the PSU space could be an excellent bottom-up investment strategy, especially given the improving outlook for this sector.

PSU bank stocks have come a long way, but patience remains the key. Only three years ago, their average return on equity (ROE) was a mere 6%—today, it stands at 15%. However, the ride has been anything but smooth.

On a quarterly basis, after a stellar 23% gain in the March 2024 quarter, the sector lost steam, managing just 5% in the June quarter before slipping into the red with an 8% drop in the September quarter and another 4% decline in the December quarter. The pattern is clear—after a strong rally, profit booking has taken centre stage, pointed out Rajan.

Gupta said PSUs in the power sector are quite cheap again and hence attractive. He likes power sector-focused specialized non-banking financial companies and power generators, both renewable and conventional. He added that select defence and railway PSUs continue to be attractive.

He also likes PSU banks, especially the larger ones. These are in a sweet spot like defence and railways were about 4-5 years ago. Further, with bank non-performing assets at decadal lows, clean balance sheets, higher capital to risk (weighted) asset ratios than the regulator’s requirements, they have a large unutilized lending capacity and a huge growth opportunity over the next 3-5 years, he said.