The current valuation is around 50 per cent higher than the Nifty’s historical average earnings multiple of around 19x, raising the risk of a sharp correction at the first whiff of bad news.
Analysts attribute this growing wedge between the earnings and stock valuations to investors’ expectations of supernormal growth in corporate earnings over the next four quarters and the surge in liquidity in the equity markets
after a dovish stance of the US central bank last quarter. Bond yields in the US are down by nearly 65 basis points in the last one year, fuelling a global rally in equities. One basis point is one-hundredth of a per cent.
“Institutional investors, especially, foreign portfolio investors, are building a case for a strong rebound in corporate earnings in FY20, driven by a low base in FY19 and a sharp turnaround in large companies such as Tata Motors and State Bank of India. Many brokerages expect up to a 60 per cent jump in the combined net profit of BSE 500 companies over the next 12 months,” says Dhananjay Sinha, head of research, Emkay Global Financial Services.
The optimism is visible in the index forward earnings estimates. The Nifty50
companies’ combined net profit is expected to grow by 45 per cent during 2019-20 over the previous fiscal year, according to Bloomberg consensus estimates. On average, brokerages expect the Nifty
underlying EPS to touch Rs 635 by the end of the Q4 FY20 earnings season, as against an expected EPS of Rs 438 at the end of the current earnings season (Q4 FY19) and Rs 401 currently.
Analysts, however, question the Street’s optimism on corporate earnings, given its poor record in the past.
“Corporate earnings are down around 18 per cent in the last one year and Nifty
50 companies’ combined net profit has grown at an annualised rate of just 7 per cent since FY08. Earnings are likely to remain in the slow lane given the headwinds in the global economy and a slowdown in consumption demand in India,” adds Sinha. Others attribute the current rally to a surge of foreign investors’ inflows. “The market is being driven by inflows from global exchange traded funds
(ETFs) through machine or algorithmic trading. This is short-term money trying to play on market momentum and has hardly anything to do with the underlying corporate fundamentals in the India,” says G Chokkalingam, founder and MD, Equinomics Research & Advisory Services.
He is advising domestic investors to stay away from the momentum given its weak fundamentals. “ETFs will pull-out money at the first hint of bad news
leaving domestic investors to hold the can,” he adds.