Equities – Plateauing Earnings Growth In The Near Term

The GDP numbers present a picture of revival in economic activity from the depths to which it had fallen during the first wave of the pandemic. GDP growth Q4 FY 21 is at 1.60%, compared to just 0.50% in Q3. For the whole year the GDP growth is at -7.3%, which amply reflects the stress the economy was going through for almost a year. While industrial activity has shown some improvement, it is agriculture that has been consistently performing well, for the last two years or 8 quarters agriculture has recorded uninterrupted growth. The services sector remains affected as the contact-intensive areas still remain in the low employment-output territory. The lockdowns that we have seen in the last few months due to the second wave of the pandemic, though the lockdowns were not universal as it was last time, may leave some impact on growth and earnings too. Given the spread and intensity of the second wave, the growth concerns are not entirely behind us, and the economy may require continued monetary and fiscal support, at least over the next two quarters. The reassurance of an accommodative stance in the recent monetary policy, and additional liquidity-centric measures from the central bank like the GSAP 2.0 will help keep the rates stable for a while.

The earnings season has so far maintained the buoyancy and momentum set by the results in Q2 and Q3 of the last FY. While operational efficiencies helped in Q1, business factors and improved business conditions post the opening up of the economy helped in substantial recovery in the subsequent quarters. Pick up in earnings is closely intertwined with the rate of economic growth, and the revival in growth helped revival in earnings too. The expansion in valuations was supported in a major way by the supportive liquidity conditions as well as low interest rates. The recovery in demand conditions helped companies in a major way in realising the sales and profitability objectives though to some extent the low base from where they are coming also helped.

One interesting factor of the results this time compared to the Q2 and Q3 numbers is that last two occasions the number of earnings upgrades was higher than the earnings downgrades. This time around the scenario is slightly different. There have been fewer upgrades so far and more downgrades though not substantial. Cement, Metals, NBFCs are the sectors which have seen earnings upgrades while auto and consumer segments have seen downgrades. The importance of sustainable demand in the pick-up of these sectors cannot be ignored. High input costs, high prices of commodities etc. are factors that may affect performance in the coming days too.

There is uncertainty on the rate of economic growth and therefore, the earnings visibility would also be much less due to the lockdowns in several states and covering major cities and twins. If we take the top 20 cities and towns which help companies generate 80% of their business, it can be seen that the basic parameters of business growth may be weakened if not significantly. The other factor that may affect earnings is the limit to the operational efficiencies – during the last financial year corporates were able to somewhat protect profitability despite the impact to topline numbers due EBITDA margin expansion. If the demand scenario remains weak owing to prolonged lockdowns, this time around there could be more pressure on profitability. Growth rate has been revised downwards to 8 % to 9 %. This may be of consequence for the Q1 of FY22, but there is lot of time left for catching up with performance for the rest of the year provided the conditions ease and normalcy returns.

In the pursuit of long-term portfolio performance, the focus on value at a reasonable price need to be adhered to, more particularly at this point of time. The domain one should be concentrating on, should be well managed funds, from the mutual funds space and portfolio management services, as also alternate investment funds based on themes which have played out well in the past too. The midcap segment, and to some extent small cap funds, should get precedence in the scheme of allocation. Systematic investments, a phased approach, over a period of 6 to 12 months is worthwhile approach to creating investment portfolios.


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