The great Indian hope trick
India’s growth story is so compelling, investors are willing to ignore years of flat and even declining earnings in the hope that the elusive growth will come about at some point in the future.
Analysts at Kotak Institutional Equities list a number of examples in a 5 June report where “investors are enamoured by the performance of a stock and are oblivious to the financial and operating performance”. Of course, this is true for nearly the whole market, in varying degrees.
ACC Ltd’s earnings per share, for instance, has declined 55% between fiscal years 2013 and 2017 (FY13 and FY17). Meanwhile, the ACC stock has risen by more than 40% since April 2013, which means that its trailing price-earnings ratio has more than trebled to 47 times, from around 15 times earlier.
The trend is much the same with Ambuja Cements Ltd, although because UltraTech Cement Ltd managed to maintain earnings at the same levels as four years ago, its stock has been rewarded with a 120% appreciation in value.
The report lists a few other stocks such as Nestlé India Ltd, which now trades at an outlandish 67 times trailing earnings. The consumer goods company’s valuations have risen from around 41 times earnings four years ago, despite declining earnings during this period.
While these are extreme examples, companies in general haven’t done enough to warrant the endless increase in valuations. Earnings of firms that constitute the National Stock Exchange’s Nifty index have been more or less flat in the past four years, while the index has risen by around 70% since the end of FY13.
Of course, the argument goes that growth will inevitably come, and that current prices are discounting future earnings. But it’s worthwhile noting that in end-FY13, investors had been factoring in double-digit earnings for the following few years. As it turned out, all of those hopes came to nought. Well, almost—Nifty earnings have risen at a compound annual growth rate of around 3% between FY13 and FY17.
Kotak’s analysts have another note of caution: “The market is presumably looking at a strong recovery in the financial and operating metrics of these companies and many other similar companies. Volumes will inevitably grow in a country like India. However, profitability is another issue and we believe investors may be too generous about profitability assumptions across sectors.”
There’s a difference between having hope and being smug. Investors in Indian equity markets are making it increasingly clear that the second description fits them best.