 "Forward earnings forecast can mislead")
Bulls have been selling the India growth story to equity investors for years, despite India Inc having repeatedly failed to match up to the bullish earnings projections of the country's top brokerages.
Every year since the 2008 Lehman crisis, combined earnings of the Nifty 50 companies has fallen short of the forward earnings (FE) estimates calculated by these broking houses at the beginning of a financial year.
The pattern is familiar. Every year, the FE estimates for the Nifty 50 companies prepared by brokerages start from a high base in the first quarter. Then, downgraded in the subsequent quarters as actual corporate earnings fail to match up to the Street estimates.
For example, the Nifty FE estimates for FY15, first put out in May 2012, were pegged at Rs 522 a unit of the Nifty index. This was progressively downgraded to Rs 415 when the last estimates were published in May this year. Even this turned out to be on the higher side and Nifty companies ended FY15 with underlying earnings per share (EPS) of around Rs 360.
The analysis is based on the Bloomberg consensus earnings estimates for the benchmark Nifty index beginning financial year 2007-08. These estimates are themselves based on the earnings projections by various brokerages. The historical time series data has been sourced from broking house Emkay Global Financial Services.
The data suggests Street estimates have always run ahead of actual earnings on a trailing 12-month basis and the gap has only widened over the years. For example, the Nifty current EPS at Rs 360 is lower than optimistic Street estimates for 2008-09. In September 2007, at the height of the pre-Lehman crisis boom, analysts were expecting the Nifty EPS to cross Rs 400 by the end of FY09.
The FE for this financial year and the next are equally ambitious. Despite recent downgrades, the benchmark index is expected to report underlying EPS of Rs 487 in FY16 and Rs 577 in FY17. This requires earnings growth of 35 per cent in the next three quarters. For FY17, the implied annual growth in earnings is 18.5 per cent. In comparison, Nifty companies' underlying earnings have grown at a compounded annual rate of 8.8 per cent in the past five years and have seen a five per cent decline in the past year.
The growing gap between actual and projected earnings has made Indian equity one of the costliest in the world. This, in turn, has made the market volatile, as investors start selling at the first sign of economic or financial trouble. "The market has been in exuberance for many years, fed by benign liquidity flow from foreign institutional investors. This puts pressure on analysts to justify the higher valuations by coming out with equally bullish earnings estimates" says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.
The Nifty is currently valued at 21.8 times its underlying earnings in the trailing 12 months or nearly 2.5 times the underlying earnings growth in the past five years. The current valuations are similar to that in the run-up to the 2008 Lehman crisis, when earnings were growing at 20-plus per cent year-on-year, against single-digit growth now.
Experts say for any stock rally to sustain, the price to earnings growth ratio should be one or less than one. In other words, price to earnings ratios should never exceed the growth in underlying EPS.
Bulls, however, feel otherwise. "Earnings growth has been below par in the past few quarters but the future looks bright. The economy is turning around and corporate earnings will accelerate from the last quarter of the current financial year or, at best, the first quarter of the next one," says Vikaas M Sachdeva, chief operating officer, Edelwiess Asset Management.
Sachdeva sounds right if we take forward estimates at their face value. At its current level, the Nifty is valued at a juicy 16 times and 13.6 times the underlying forward EPS for FY16 and FY17, respectively. The only hitch -- to achieve the target, the earnings of top companies have to grow at four times their pace in the past five years. This looks a long shot.
