Photo: Mint
Photo: Mint

Stock markets face a risk that can hit sentiment in the medium term

  • A sharp fall in the Nifty 50’s earnings is not helping ease valuations
  • The problem is that the correction has not helped lower valuations in any way

The downward spiral in the Indian stock market could get more acute if the earnings cycle does not turn soon.

A sharp fall in the Nifty 50’s earnings is not helping ease valuations. In fact, valuations have expanded since January 2019.

The Nifty 50’s earnings per share (EPS) hovered about 415 in January 2019, as per data from the National Stock Exchange Ltd. The EPS has since shrunk to 405 if one looks at the trailing 12-months numbers on the NSE website.

The problem is that the correction has not helped lower valuations in any way. On the contrary, the price-earnings (PE) multiple has remained elevated. In fact, since January 2019 the Nifty 50’s PE increased from 26 times earnings to about 27.6 times currently.

That means that stock prices still remain elevated, and the Nifty’s current valuations is not much comforting.

After all, a correction in the market essentially should reflect in lower valuations. If the earnings are falling, the market’s valuations could continue to look stiff and overvalued despite a correction.

To top it, the bigger risk for investors is the lack of earnings triggers in the coming quarters. The slowdown in vital sectors of the economy is likely to drag down the Nifty’s earnings even further. Analysts have already begun downgrading the Nifty’s earnings in the current year.

“Consensus Nifty FY20/21 EPS is currently forecasting a growth of 23%/18% with nominal GDP growth assumption of 10% - which indicates high risk of meaningful earnings downgrade (correlation between Nominal GDP and Nifty EPS is at 0.65; significant divergence exists for FY20-22)," said analysts at PhillipCapital (India) Pvt. Ltd in a note to clients.

As such, scores of companies reported poor first quarter results which include the likes of Tata Motors Ltd, Yes Bank Ltd, Maruti Suzuki Ltd among others.

Many critical sectors face a sluggish demand condition. “We are expecting growth to taper in favoured sectors like consumer discretionary, infrastructure (roads), and chemicals (reflecting broader economic weakness) along with negativity persisting in automobiles, pharmaceuticals, FMCG, and metal," said PhillipCapital in the note.

As things stand, if the demand conditions don’t begin to improve starting next quarter, earnings downgrades could even escalate from the present levels.

In fact, analysts at Antique Stock Broking Ltd which downgraded Nifty earnings by 2.6% for FY 20 said in a client note that “Further earnings downgrade of 2-3% can’t be ruled out owing to overall economic slowdown."

That does not bode well for the markets. After all, both a price and an earnings correction can be a lethal combination, one that can crush investor sentiment.