While the Nifty 50 has rallied nearly 12.5 per cent between July 2017 to July 2018, its P/E multiple on a trailing earnings basis has peaked to over 26 from approximately 23 about a year ago (and 21.6 in the previous two years). In other words, the 12.5 per cent rally over the past year is not backed by growth in earnings.
Most sectors are quoting at a 20-40 per cent premium to their 10-year average P/Es. While the Nifty EPS was between Rs 378 and Rs 417 in the period from FY14 to FY17 .The Nifty rose 61 per cent in the same time span. The main reason for this rise was expectations of a recovery in corporate earnings.
The rally was also fuelled by FII funds, and by local investors, who jumped into the fray bringing in fresh inflows towards the latter part of the rally. In this period, India's quarterly GDP fell from a high of 8.81 per cent in Q2FY15 to a low of 6.07 per cent in Q4 of FY17. There is a close correlation between economic growth and corporate earnings. The current market rally seems to be ignoring valuations, and also the lack of earnings growth. This is primarily owing to increased hopes of recovery. However, we have to be mindful that Nifty earnings are impacted by cyclicality in metal and oil companies' earnings, and also by banks' numbers (which keep fluctuating owing to regulatory diktats) from quarter to quarter, and also on an annual basis (YoY). Sometimes, the earnings growth of companies comprising the Nifty is also used to represent the health of the economy, as economic growth would eventually translate into EPS growth of these companies.
While economic growth definitely benefits the overall earnings growth of all companies, its translation into earnings growth at the micro level is often diluted. The macro opportunity need not necessarily translate into micro gains.
Most sectors are quoting at a 20-40 per cent premium to their 10-year average P/Es. While the Nifty EPS was between Rs 378 and Rs 417 in the period from FY14 to FY17 .The Nifty rose 61 per cent in the same time span. The main reason for this rise was expectations of a recovery in corporate earnings.
The rally was also fuelled by FII funds, and by local investors, who jumped into the fray bringing in fresh inflows towards the latter part of the rally. In this period, India's quarterly GDP fell from a high of 8.81 per cent in Q2FY15 to a low of 6.07 per cent in Q4 of FY17. There is a close correlation between economic growth and corporate earnings. The current market rally seems to be ignoring valuations, and also the lack of earnings growth. This is primarily owing to increased hopes of recovery. However, we have to be mindful that Nifty earnings are impacted by cyclicality in metal and oil companies' earnings, and also by banks' numbers (which keep fluctuating owing to regulatory diktats) from quarter to quarter, and also on an annual basis (YoY). Sometimes, the earnings growth of companies comprising the Nifty is also used to represent the health of the economy, as economic growth would eventually translate into EPS growth of these companies.
While economic growth definitely benefits the overall earnings growth of all companies, its translation into earnings growth at the micro level is often diluted. The macro opportunity need not necessarily translate into micro gains.
Stock markets, earnings and the economy have their own respective cycles. Stock market cycles precede earnings, and earnings precede economic cycles.
Sell side analysts, who have the practice of forecasting Nifty EPS, have been caught on the wrong foot over the last few years. They start the year with earning expectations of 15% to 20 per cent. However, as the year unwinds, it comes down to 5-6 per cent. The process is then repeated.
They start all over again with the same figures of 15-20 per cent, and then again lower it to 7-8 per cent. The EPS is an important fundamental used in valuing a company, because it breaks down a firm's profits on a per share basis. Growth in EPS is an important measure of the management's performance, as it reflects the quantum of money the company is making for its shareholders, mainly due to greater changes in profit.
Sell side analysts, who have the practice of forecasting Nifty EPS, have been caught on the wrong foot over the last few years. They start the year with earning expectations of 15% to 20 per cent. However, as the year unwinds, it comes down to 5-6 per cent. The process is then repeated.
They start all over again with the same figures of 15-20 per cent, and then again lower it to 7-8 per cent. The EPS is an important fundamental used in valuing a company, because it breaks down a firm's profits on a per share basis. Growth in EPS is an important measure of the management's performance, as it reflects the quantum of money the company is making for its shareholders, mainly due to greater changes in profit.
The market price of any stock is a function of two elementsearnings per share (EPS) and the price to earnings (PE) ratio. Movement in these two variables is in turn dependent on various factors. If the earnings of a company grow, assuming the PE stays constant, its market price will increase.
Similarly, even if the earnings of the company remain stagnant, the stock price can still increase on the back of an expansion in PE multiples. While the first type of price increase is on the basis of realised past performance reflected in the earnings growth of the company, the second type of price increase is based on expectations of a brighter future.
While P/E expansion can be temporary based on inflows, the interest rate trajectory and alternative asset classes' outlook, a more permanent rerating in the market needs sustained earnings growth.
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