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Even if Modi comes back, the market is too costly PDF Print E-mail
Wednesday, 22 May 2019 03:42
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While there is some premium to be paid for a stable government, the stock markets have run well ahead of themselves. There is no reason markets should be trading at such expensive valuations when corporate earnings are so poor; for a universe of 608 companies (excluding banks and financials), net profits in Q4FY19 fell 15.2% year-on-year (y-o-y) on the back of a revenue growth of 11.7% y-o-y. Excluding RIL and TCS, the net profits were down 22% y-o-y, with revenues up just 10.3% y-o-y. The results tie in with the data—subdued sales of cars and two-wheelers, muted demand for electricity , and a contraction in factory output in March. Even volumes of staples are slowing.

The problem is the Street has consistently over-estimated earnings for some four years now. Even for FY19, estimates were earlier pegging growth at 20%-plus whereas the reality has turned out to be quite different. Consequently, as earnings under-performed expectations, the broader market too under-performed. Before last Friday’s rally, a whopping 80% of stocks with a minimum market cap of `1,000 crore had lost value over the past one and a half years.

Many would argue, and very rightly, that stock markets price in the growth in future earnings. On the low base of FY19—earnings will grow by just about 13%—the growth in earnings in FY20 is now estimated to be a robust 22%-plus. Apart from the benefit of a low base, corporate India has little going for it. Unless private investment picks up, consumption can’t get too much of a boost since government can’t spend beyond a point. But, unless there are clear signs of a pick up in demand, the private sector is not about to add capacity.

In any case, there is some production capacity available via the inorganic route, which typically doesn’t create more jobs. Sectors such as real estate and construction need to be revived before we can see a big revival in demand. The routine government expenditure of around `22-23 lakh crore can take growth and consumption only up to a point. Tax collections will be under pressure in FY20 given how the economy is slowing sharply—GDP is expected to clock only 6.5% y-o-y in Q4FY19. Again, there are those that have pointed out that some of the moderation in consumption has been caused by the lack of credit post the NBFC crisis and that once liquidity is available, demand will see a rebound. That may be true, but purchasing power comes from well-paying jobs and the confidence that those incomes will continue. RBI noted recently the increase in household savings has been slowing since incomes are not growing fast enough.

The fact is that the twin balance sheet problem has taken a huge toll on the economy, and it could be another two-three years before corporate leverage returns to manageable levels. In that process, some more wealth will be destroyed, and a few more companies will close down. As for state-owned banks, given the NPA cycle isn’t over yet, they will find it tough to gather growth capital without which they can’t lend. In the meantime, high crude oil prices and sluggish exports will keep the economy in the slow lane. If, after all this, India is one of the most expensive markets in the world today, trading at just under 19 times the one-year forward earnings, one can only assume investors are willing to wait it out.

 

 

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