Corporate earnings failed to keep pace with GDP growth in the past decade

Corporate earnings have failed to keep pace with the trajectory of nominal gross domestic product (GDP) over the past 10 years. The combined net profit of listed companies has grown at a compound annual growth rate (CAGR) of 4.1 per cent, against 12.9 per cent growth in India’s GDP at nominal prices during the period.

In rupee terms, companies’ combined net profit is up 50 per cent, from Rs 2.6 trillion in 2007-08 (FY08) to Rs 3.9 trillion at the end of 2017-18 (FY18). On the other hand, economic output, or GDP at nominal prices, is up 234 per cent, from Rs 50 trillion in FY08 to Rs 167 trillion last fiscal year, leading to a sharp fall in the ratio of corporate profits to underlying GDP. Corporate profits were equivalent to 2.3 per cent of GDP (at nominal prices) in FY18, down sharply from 5.2 per cent a decade ago (see chart below).

The poor performance of earnings over the period is not entirely due to losses of public sector banks. Corporate earnings, excluding banks and financials, grew at a CAGR of 6 per cent in the last decade, underperforming GDP growth by a wide margin.

Corporate earnings growth has been lower than GDP growth in eight out of last 10 years, while companies’ revenue growth has trailed the latter in six out of last 10 years.

The country’s top 30 stocks, part of the BSE Sensex index, have done marginally better. The underlying earnings per share (annual average) of index companies grew at a CAGR of 6.5 per cent between calendar year 2008 and 2018. The trailing 12-month earnings per share (EPS) have grown from Rs 795.4 in 2008 to Rs 1,498 now (2018 average).

Corporate revenue growth also continues to trail headline GDP numbers, despite recent boost from higher commodity prices. In the last 10 years, companies’ revenues (net sales) have grown at a CAGR of 10.8 per cent, against 12.9 per cent annualised expansion on nominal GDP during the period.

In rupee terms, companies’ combined net sales grew 179 per cent over the last decade, from Rs 25.2 trillion in FY08 to Rs 70.1 trillion at the end of last fiscal year. Corporate revenues were equivalent to 50.4 per cent of GDP in FY08 and they declined to 41.8 per cent of GDP in FY18.

The analysis is based on the annual audited results of a common sample of 868 companies across sectors that are part of the BSE 500, BSE MidCap, and BSE SmallCap indices. The data excludes the listed subsidiaries of operating-holding companies such as Vedanta, Mahindra & Mahindra, Larsen & Toubro, Bajaj Finserv, Tata Steel, and Grasim Industries, among others, to avoid double-counting of numbers.

Poor earnings have also created a wedge between corporate earnings and stock prices. The combined market capitalisation of companies in our sample has nearly tripled during the period, growing at an annualised rate of 10.8 per cent during the period. As a result, companies’ prices to earnings multiple for the sample jumped to 30x at the end of March this year, from 16.6x at the end of March 2008.

Experts attribute this to the uneven economic recovery after the 2008 global financial crisis. “Corporate capital expenditure cycle is yet to recover and most of the growth in the last few years has been concentrated in consumer-oriented sectors, including retail lending. This has put a lid on overall earnings growth,” says Saurabh Mukherjea, founder, Marcellus Investment Managers.

According to him, the broader BSE 100 index has delivered 8-10 per cent annual returns in the last 10 years, depending on the entry point for investors, which is not bad, given the macroeconomic challenges that bedevil Indian economy. “There are no guarantees in equities and many large markets have seen long episodes of 12-15 years when investors got no returns,” he adds.

PhillipCapital says that 2011-17 was the toughest for corporate earnings, with the 50-stock Nifty index underlying EPS growing at a CAGR of just 4.5 per cent, and earnings saw significant downgrades through the years. “We believe sluggish earnings growth in the past six years has resulted in a favourable base and therefore, chances of downgrades are not very significant. And, in fact, earnings growth is more likely to be robust in the current fiscal year and beyond,” write PhilipCapital’s Neeraj Chadawar and Naveen Kulkarni in their recent India Strategy report.

Others flag the issue of the growing uncompetitiveness of the corporate sector as indicated by a persistent decline in companies’ operating margins and productivity since the global financial meltdown. “After 2008, structurally things have changed such that companies are not able to deliver earnings growth even when they experience top line growth. For companies, operating costs are running ahead of pricing power, while return on equity remains depressed due to suboptimal capital utilisation,” says Dhananjay Sinha, head of research, Emkay Global Financial Services.

According to Sinha, lack of competitiveness is most visible in a steady decline in India’s participation in global trade. “International trade (exports plus imports) accounted for nearly 60 per cent of India’s GDP in 2008; it’s now down to 40 per cent. This has shrunk market opportunity for companies hitting capacity utilisation and returns ratios,” he adds.

International trade accounted for around 15 per cent of India’s GDP on the eve of the 1991 economic reforms.