Nifty-50 returns contribution: multiple expansion versus earnings growth
A large part of the Nifty-50 returns in recent years has come from multiple expansion rather than earnings growth. The accompanying chart shows the contribution of earnings changes and multiple changes to each year’s returns of the Nifty-50 index for the last 10 years. Kotak Institutional Equities uses 12-month forward earnings for computing the breakdown between “EPS” and “P/E” contribution. For instance: the 25% return for calendar year 2017 represents a 9% increase in multiples and 15% likely growth in 12-month earnings over the same period.
EPS is short for earnings per share and P/E stands for price-to-earnings ratio.
However, Kotak says it would be careful about assuming that the high multiples of stocks (along with high profitability and returns) in several sectors will hold up in perpetuity or even the next 12-18 months. That’s because several companies in India have much weaker business models than their multiples suggest, according to the brokerage. “They do not have any great ‘moats’ in the form of world-class technological capabilities and mostly benefit from some combination of (1) regulatory vacuum and (2) incumbency, which impart artificial strengths to their otherwise mediocre business models,” Kotak said in a report on 8 December.