Stock markets have been on a tear over the past 18 months and it has been very broad across industries this time. Small cap companies and generally laggard industries such as metals, stock broking, engineering and textiles have done really well. Nifty trailing PE multiples seem to be at a high level of 27 times, a sign generally associated with market exuberance.
I think that much of what is happening is for real. Several Indian and global policy initiatives set up the base for this performance. One, India undertook several structural reforms like reduction in corporate tax rates, GST implementation, liberalised agricultural trading, and over the past one year, launched multiple industry-specific PLI schemes promoting capex. Two, a number of countries have infused large stimulus into the global economy, and finally, globally a China plus one strategy is taking shape prompting more investments into India.
A lot of discussion has normally been around macro drivers, but let us explore bottom up, if companies have generated strong EPS growth to justify the strong stock price appreciation. We run a proprietary algorithm that finds companies in the sweet spot of strong earnings performance after every quarterly results announcement, for the past 10 years. This list has been very useful for shortlisting potential investment targets. On average, one in two of these shortlisted companies have delivered at least 20 percent price appreciation over the next 12 months. It has also been a good pointer for the prevailing and upcoming economic situation. Table shows accelerating number of companies that delivered strong EPS growth from late 2020 onwards, strongly justifying recent market exuberance.
Some sectors like metals, broking, chemicals, IT have seen very strong earnings growth. Tata Steel has earned `8,150 crore in profits in just one quarter ending March 2021, while in its previous best year 2019, it had annual 12 months profits of `9,300 crore. Companies like Deepak Nitrite, which planned new capex in 2017/18, reported 10 times increase of profits to reach `979 crore in the recent 12-month period. Strong investor interest in markets is also showing in explosive growth in the number of DMAT accounts. This has propelled share prices of CDSL, India’s leading securities registrar, and stock broking firms like ICICI securities and Motilal Oswal. The IT industry is in a sweet spot thanks to global corporate digitalisation initiatives. An upsurge in the large US markets is contributing to this growth and visibility for the sector. Such examples are plentiful across sectors and sizes of companies.
Let’s now look at valuations. Trailing Nifty PE valuations of ~27 times is indeed high at first glance. This was calculated on July 30, 2021, by dividing Nifty (15,763) by trailing 12 months consolidated earnings of `583 per share (Source: NSE). Let’s consider the following. The trailing PE is based on 12 months starting April 2020 up to March 2021, which included one full quarter, i.e, April-June 2020 in national lockdown. Another factor to consider is the dominance of the financial sector in our Nifty (~40 percent share) and that this sector has been reporting weak performance due to Covid-related shutdowns and NPAs. Considering the above, the real Nifty PE levels for companies that are performing well should be reasonable.
Finally, let’s now examine the future company earnings outlook as market prices discount forward earnings. Export performance has been strong. Many of the large listed Indian businesses are export-focussed. IT, pharma, chemicals, textiles, metals, engineering seem to be in structurally positive space and this is likely to continue given strong stimulus and growth in our key western exports markets. For example, a generally laggard textiles sector seems positively biased due to problems with our competition from Chinese Uighur province and Pakistan cotton exports.
Also, India’s policy on ethanol and agri reforms seem to have unleashed a period of strong rural India growth. Many pundits are comparing India’s stage of economic growth and opportunities to the 2003-08 period when we had a wonderful period of growth. India seems to be in a similar period of strong outperformance.
Having said all this, this bull market has boosted the share prices of most companies, even those without strong earnings growth. This means investors will now need to carefully assess forward earnings growth and the quality of news flow for each company/sector before taking positions.
(badri@equitylevers.com)