The mojo of PSU bank stocks might fade away soon

PSU banks have been in focus for quite some time due to several tailwinds, as most entities are performing well both internally & externally from maintaining healthy asset quality to several governments' initiatives where PSU banks are the beneficiaries. The PSU Bank Index has risen by more than 56% in the last 1 year, the Nifty Private Bank Index rose by just 14%, and in the same period Bank Nifty by 13%, making PSU Banks the leader of the segment.

The government kickstarted the rally through banking reforms such as the establishment of Bad Banks to move the long outstanding NPAs out of the books, the implementation of the Insolvency & Bankruptcy Code helping banks to recover their debts and, merger of several PSU banks enabling them to have a more focused approach on their operations.

The current government's focus on long-term projects of infrastructure, power, and agriculture would benefit PSU banks more than private banks as they traditionally have higher exposure in these sectors. This is one of the factors due to which the share prices are soaring to new highs.

PSU Banks usually trade at a low Price-to-Book value but currently, they are trading at the highest levels compared to their historical valuations. The valuations look stretched.Share price appreciation happens because of two main reasons: Earnings expansion and perception-led growth or multiple expansion.

The former can be computed based on financials on a quarterly and yearly basis and the latter could be assumed as the difference between share price CAGR and earnings growth CAGR. The lower the difference, the higher the safety and vice-versa. The current rally in several PSU Banks is more because of multiple expansions rather than earnings expansion.