Corporate earnings are accelerating, which holds a new ray of hope for Indian equity markets reeling under the triple weight of depreciating rupee, rising oil prices, and stiff valuations. Even as political developments keep equity investors on the edge amid rising volatility, investors should not take their eyes off earnings. Sales and profits are known to drive stock prices over the long-term. With the incremental growth in earnings, finally, the long-term domestic investor might be getting some relief.
As many are aware, the GST, the demonetisation event, and the implementation of RERA have been one-off events in the past 18 months which has made the overall corporate environment challenging. Besides, the weak investment and credit cycle and the recent surge in commodity prices especially oil too have held back system growth. As we move over some of these issues and as India integrates more tightly into the global growth cycle, many expected more uniform corporate earnings recovery.
Earnings for the universe of 290 companies quarter to date are up 13.3 per cent year-on-year, excluding PSU banks, ICICI Bank, Axis Bank and Tata Steel. Large cap and mid cap companies lead the profit charge even as small caps struggle. Sectors like real estate, healthcare and industrials have done well so far in Q4, while telecom and PSU banking have disappointed. The economy remains healthy, earnings are coming through and structural reforms are underway. This might set the stage for the third leg of private investment to come forward.
However, significant damage has been inflicted on equities in the past few months, particularly mid and small caps. This makes equities look better positioned today, than they have for some time now. It is important to view corporate in this prism. The earnings so far for corporates have come through recently with the majority (more than 50 per cent) either beating or delivering results in line with consensus estimates. Interestingly, the dispersion in long-term earnings expectations between large and mid-caps is marked.
Going forward, while mid-caps are expected to outperform on an absolute basis, the consensus now expects a significant improvement in earnings for large-caps vs. a deceleration in mid-caps. The P/E for small caps is 31.2 times, while mid caps are at 23.2 times and large caps are 22.2 times. Good corporate earnings numbers have been the only positive factor in the bunch of negative news including Italy crisis.
While the outcome of the RBI monetary policy, macroeconomic data, fuel prices and global market trends will dictate the momentum next week, investors can take heart from encouraging earnings growth numbers and can take bets accordingly. There has been limited communication from the central bank since the April policy meeting. This makes the policy review on June 6 important to gauge the RBI’s assessment of recent market volatility and hardening in borrowing costs. But if the 7.7 per cent growth in Q4 GDP and latest quarterly earnings scorecard are any indicators, the RBI could very well assume that the economy is slowly crawling out of the pit.