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Business News/ Markets / Mark To Market/  If Q3 results weren’t that bad, why are Nifty EPS estimates still falling?

If Q3 results weren’t that bad, why are Nifty EPS estimates still falling?

  • Earnings estimates of listed companies have been cut by 11% since the beginning of 2019
  • Valuations have been rock solid on the assumption that growth will catch up at some point in time

Indian markets seem to be having a heady cocktail of earnings cuts and a higher-than-usual valuation premium.

"Optimism doesn’t wait on facts. It deals with prospects," said American journalist Norman Cousins. Stock market investing is a lot like that. Investors and traders are often pricing in future prospects. It’s another matter that in the case of Indian equities, investors’ predictions about future earnings prospects have repeatedly turned out to be over-optimistic.

The current fiscal year has been no different. At the beginning of FY19, consensus earnings per share (EPS) estimates for the Nifty index for FY20 were as high as 730. With FY19 earnings turning out to be far lower than expectations, FY20 earnings estimates now stand reduced to 650. Besides, while several brokers have said that the third quarter (Q3) results were more or less in line with expectations and were not that bad, the Nifty EPS has come down during this earnings season as well, by 3.7% to be precise.

“There have been meaningful earnings cuts for refiners, metals companies, some banks, and consumer discretionary companies. When earnings of heavyweights such as Reliance (Industries) and SBI (State Bank of India) are cut, it naturally has a bearing on the Nifty EPS estimate," said the research head of a multinational broking house, requesting anonymity.

Refining margins were weaker than expected and so were passenger vehicle sales. Factors such as higher-than-expected pension provisioning hit calculations related to SBI’s earnings, while for others, such as ICICI Bank Ltd, growth forecasts are now lower than before.

Hopes of a significant turnaround in earnings are subdued and vlautions of Indian equities remain expensive.

Whatever the reason, the continued earnings cuts don’t augur well for the markets. As the chart above shows, while earnings estimates have been cut by 11% since the beginning of the year, valuations have been rock solid on the assumption that growth will catch up at some point in time.

The markets have not reacted to the cut in earnings because they were in the sub-4% range for the current earnings season, said the head of research quoted above. A tad higher and this may well have been a trigger for a correction.

In any case, consensus earnings estimates now assume 25-30% growth in earnings in FY20, with the bulk of the increase expected to be driven by banks and other financial firms. Kotak Institutional Equities said banks and diversified financial sector would account for the bulk of the incremental profits of the Nifty 50 index in FY20 at 59%.

Not everyone is, however, convinced. The low base of earnings in sectors will aid earnings growth, but the absence of a broad-based pickup in private investments and lower return on capital employed for leveraged companies would restrict significant improvement, say analysts.

“Even after considering the base effect of corporate lenders, we believe earnings growth for Nifty 50 may not exceed ~15% over FY19-FY21. Like the Stockdale paradox, we remain optimistic about an eventual pick-up in India Inc’s earnings growth given that it has lagged nominal gross domestic product trajectory (ranging between 10 and 12% since FY17 against the Nifty 50 average growth of 5%), but remain cognizant of the fact that the recovery is yet to happen," ICICI Securities Ltd said in a report on 18 February.

Besides, the one-year forward price-to-earnings multiple of MSCI India is at 17.34 times, higher than the 12.35 times valuation of MSCI Asia ex-Japan by quite a margin. All told, Indian markets seem to be having a heady cocktail of earnings cuts and a higher-than-usual valuation premium. How long they can stand remains to be seen.

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