There has been a lot of anecdotal evidence that small companies are the ones that have been hurt badly by the rise in interest rates, on the one hand, and the appreciation of the rupee, on the other.

To test whether these stories are true, or if they have been inspired by vested interests, we have checked out how the really small companies have performed in the last few quarters. We have taken companies that have a quarterly net turnover of between Rs1 crore and Rs50 crore in the Capitaline Databases and compared their year-on-year performance in the March, June and September quarters of 2007.

The results are pretty clear —on all three parameters, the 1,515 companies in this category showed a slowdown. At the profit after tax level, however, the year-on-year change in the September quarter was more or less the same as in the June quarter. And while profit growth may have slowed, it’s still a high 28.7%, well above the growth rate shown by some of the largest companies.

But it’s important to note that core operating profit of these companies have grown just 12.2%, much lower than the growth reported by larger-sized companies. In addition, things aren’t so rosy for the export-oriented sectors within the sample.

Consider, for instance, the 72 companies in the auto ancillary sector with a net turnover of between Rs1 crore and Rs50 crore, which have seen a fall of 17.4% in net profits in the September quarter, compared with the year-ago period.

Things are even worse in the textile sector, with profit after tax falling by a whopping 75.95% in the September quarter, while they were higher by 111% in the March quarter. The small units in the leather industry, too, showed a sharp fall in profits in the quarter.

The conclusion seems to be that it’s the rise of the rupee that is the real reason for distressed results. While that has impacted companies in the export sectors across the board, the smaller companies have been hit very hard.

In the textiles industry, larger companies with revenues of more than Rs200 crore saw a much lower 1.7% drop in net profit. Large auto ancillary companies grew profit by more than 32%.

Implied earnings

China and India are the two most expensive emerging markets in Asia, even after adjusting for growth, a study by Citi Investment Research reveals.

A number of market experts have said that though price-earnings multiples of these two markets are among the highest, expected earnings growth, too, is high.

The refrain was that valuations were reasonable after adjusting for growth.

But a detailed analysis done by Citigroup Inc. shows that current valuations in China and India imply earnings must grow at an average rate of 67.8% and 60.4%, respectively, in calendar years 2008 and 2009. The universe of stocks used for the study is based on Morgan Stanley Capital International country indices.

In the case of India, earnings are expected to grow at an average rate of 25.6% in the above-mentioned period, according to consensus estimates compiled by Institutional Brokers’ Estimate System. This is far lower than the implied growth rate based on current valuations. The Citigroup research note also points out that India’s annual earnings growth rate hasn’t topped the 60.4% mark ever since 1995, the year from which such data was available.

Furthermore, China and India are also the two most expensive markets, based on a composite ranking by Citi of the price-earnings multiple, price-book value, price-cash earnings, dividend yield, enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (or Ebitda), and EV to sales based on estimates for the current year (2007).

It’s important to note that India’s return on equity has declined by 300 basis points to 19.6%.

Indian valuations seem high even based on the price-earnings growth multiple and considering that their dividend yield is among the farthest away from bond yields.

One of the criticisms is that a number of large companies have hidden value, such as Reliance Energy Ltd’s gas blocks and ICICI Bank Ltd’s insurance subsidiary.

These businesses don’t generate earnings yet, but the markets have assigned a value to them while arriving at the parent firm’s valuation. Adjusted for such hidden value, Indian valuations may seem slightly better, but it’s unlikely that they would still turn out to be cheap compared with most Asian emerging markets.

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