Public sector banks could offer the strongest alpha generating opportunity in the banking space over the medium term, according to OmniScience Capital, which believes improving balance sheets, double digit growth and attractive valuations provide significant scope for further upside.

The portfolio management services firm remains overweight on the banking sector, including public sector lenders, large private banks and mid cap private banks. Vikas Gupta, CEO and Chief Investment Strategist at OmniScience Capital, said India’s domestic economy remains resilient, with revenue and earnings growth holding up despite continued geopolitical uncertainty.

Gupta expects India could deliver more than 7 percent GDP growth in the current fiscal year. He also believes the economy could remain in a high growth phase over the current and coming years even if the West Asia conflict persists, provided other supporting factors remain favourable.

OmniScience expects markets to increasingly differentiate between companies based on their ability to generate future cash flows. In such an environment, businesses trading below their intrinsic value could see a valuation re-rating, while expensive stocks may remain range bound until earnings growth catches up with their valuations.

Within banking, the firm considers the opportunity particularly attractive because of strong balance sheets, double digit growth and valuations that remain below estimated intrinsic value. Gupta described the banking opportunity as significantly mispriced, with PSU banks offering the highest potential for medium term alpha generation.

According to Gupta, public sector lenders have some of their cleanest balance sheets in decades and are recording double digit growth in assets and revenue. Despite this improvement in operating performance and financial health, PSU banks continue to trade at substantial discounts to their intrinsic value, creating scope for valuation expansion.

OmniScience also sees potential in mid cap private banks, where valuations could unlock earlier and potentially generate higher internal rates of return. However, the firm remains positive on the broader banking space, maintaining an overweight position across PSU banks, large private banks and mid cap private lenders.

The firm remains underweight on consumer discretionary stocks despite satisfactory revenue and earnings growth, as valuations appear to already incorporate substantial expectations for future growth. OmniScience is similarly cautious on hotels, where strong fundamentals are not considered sufficient to justify current valuations without a meaningful discount to intrinsic value.

IT is another sector the firm prefers to avoid because of uncertainty surrounding future cash flows. Gupta highlighted difficulties in estimating the workforce required to deliver future workloads, making long term cash flow projections less certain.

On artificial intelligence, Gupta believes any potential bubble is more likely to be concentrated among US companies, where capital deployment towards AI has been significantly higher. Indian companies, in comparison, have not deployed capital towards AI at a comparable scale.

Gupta added that regardless of whether an AI bubble exists, the unprecedented investment by large technology companies will ultimately need to translate into higher revenues, profits and cash flows. The ability of these investments to generate sustainable financial returns is therefore likely to remain a key consideration for investors.