Mumbai: The net profit of 166 companies that have so far reported their earnings for the three months ended March grew at the second fastest pace in nine quarters, reflecting a robust economy.

The profit after tax for the 166 firms increased at an average 27.38% in the March quarter. Like in the previous quarter, profit growth was led by an increase in sales, which reinforces evidence that the economic recovery has gained momentum. The sales gain of 56.17% was the fastest in at least 10 quarters.

The results of this bunch of firms, less than one-third of which are covered by brokerages, were mostly in line with or slightly better than analyst expectations. Analysts warned that these are early days yet, as they wait for the results of firms in the industrials and metals sectors before firming up their forecasts.

“There is nothing in the tech sector or private sector bank results that will lead to major upgrades," said Apurva Shah, vice-president at Prabhudas Lilladher Pvt. Ltd. “The key numbers to watch out for will be domestic (consumption)-focused firms and industrial names."

Others are more pessimistic.

“On an aggregate basis, I suspect that we will see earnings downgrades for the market," said Girish Pai, head of research at Centrum Broking Pvt. Ltd. “This is largely because of the negative surprise from RIL. One also doesn’t know how much ONGC’s (Oil and Natural Gas Corp. Ltd) earnings will get hurt due to subsidies."

RIL reported a 30% gain in net profit for the fourth quarter ended March, but fell short of expectations as its costs more than doubled and so-called other income nearly halved.

RIL and ONGC are two of the largest constituents of the benchmark indices. Together they comprise 16.45% of the Bombay Stock Exchange’s Sensex and 14.2% of the National Stock Exchange’s S&P CNX Nifty. Any downgrades to their earnings will hit the earnings per share calculations for the indices significantly.

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The Sensex has gained only 2.61% since September, after more than doubling in the previous six months. It is trading at 21.79 times estimated earnings for fiscal 2011, higher than its long-term average. Any serious push to the market will have to come from earnings upgrades which will make the market more fairly valued.

Sales boost

While it’s too early to form a comprehensive opinion, “the pick-up in economic activity is reflecting in the topline growth," said Deepak Jasani, head of retail research at HDFC Securities Ltd. “There is a bit of margin pressure. But if the economic momentum continues, then higher costs could be passed over to consumers."

Indeed, the Index of Industrial Production grew at 15.1% in February from a year ago. The economy is expected to expand 8.8% this year, according to the International Monetary Fund. Still, the pick up in economic activity almost always leads to a rise in input costs, which hurts operating margins and profitability.

For the 156 firms, excluding oil firms, banks and finance companies, operating margin—a measure of how efficiently a firm manages its operations—fell to an average of 17.4%, from 18.45% in the preceding quarter and 19.6% in the September quarter, and is reflective of the growing cost pressures on firms.

The bunch of 166 firms includes 11 companies that are part of the Nifty. While many of their earnings were better than market expectations, the profit growth was modest.

These firms—spread across software, banks, and oil and cement sectors—posted an average 22.66% net profit growth, the fastest in nine quarters. Sales of these firms grew 58.71%, the fastest in at least 10 quarters.

The Mint analysis counted net interest income (interest earned on loans minus the cost of deposits) and non-interest income as net sales of banks. For manufacturing and services sector firms, income generated from their non-core activities was excluded from profit calculations.

Tata Consultancy Services Ltd, India’s biggest computer services firm, beat expectations with a fourth quarter profit gain of 50% as it won large deals from customers, including the UK government to administer its pension scheme, and benefited from improved staff productivity.

While its closest rival Infosys Technologies Ltd’s March quarter earnings suffered due to the rising rupee, it projected a 16-18% growth in dollar revenue for 2011.

ICICI Bank Ltd and HDFC Bank Ltd managed hefty profit growth on rising demand for loans and higher margins, which boosted net interest income. ICICI reported a 35% increase in net profit, while HDFC declared a gain of 33%.

Graphic by Yogesh Kumar/Mint