Rise in Equities: Attempting to be Logical…

Like it has been in the last three months, the indexes have risen to the highest levels in the lifetime of the markets. This rise has been facilitated by ample liquidity, hope in a faster recovery from the pandemic related setbacks, and economic numbers which instilled greater hope for the future.

Corporate profitability in India has been one of the lowest in the world. As a percentage of GDP, it was at 3 % in 2000, and this improved to 7 % between 2006 to 2008. Thereafter it declined to 3 % in 2018, and currently it stands at 2.31%. Profitability may rise due to the substantial cut in corporate taxes, significantly lower cost of funds, and the expected pick -up in economic activity and demand in the post-pandemic period. The corporate earnings results for Q2, FY 21, have been better than expected. The sales growth, even though lower on a y-o-y basis, was much better than street expectations. The outperformance has come in the EBITDA.

The growth in net sales growth for Sensex companies (for which the results have been declared till end of October 2020) came in at -6.4%, and for Sensex ex-Oil & Gas and BFSI came in at 4.4%. While the top line numbers may not look too encouraging, the EBITDA numbers present a different picture. The expected fall in demand due to the pandemic and the shutdown prompted corporates to achieve a reduction in costs. The subdued input prices along with this helped. With better GDP numbers from a contraction of 8 % to 9 % in FY 21, to a growth of probably 5 % to 6 %, in FY 22, earnings may see an improvement. Nifty EPS growth has been weak, and in fact, contracted over the last few years. The markets are yet to witness the strong EPS growth which was seen during the years prior to the financial crisis of 2008.

EPS for FY21 is expected to contract due to the economic impact of the pandemic. But a recovery in GDP growth and corporate earnings is likely due to various measures initiated by the government and the RBI, and this will help recovery in EPS in FY22. This will be at would be the critical factor as far as the trajectory of prices is concerned. Ample liquidity coupled with EPS growth, will provide the requisite impetus to market performance. The market valuations on TTM basis might look slightly expensive at this point in time but the expected earnings pick up and EPS growth will help the concerns on valuation to gradually fade away.

We are seeing earnings upgrades, after a long period of time, with a larger number of companies beating the earnings estimates. This should instil in investors greater confidence about the future when the current valuations look slightly expensive. If this goes more or less on expected lines, then the market valuations may start looking more reasonable.

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