After record rally this year, earnings test for the market optimism

Sample this: In June 2022, the aggregate profit pool for the top 600 companies was projected to touch Rs. 13.2 trillion for the ongoing financial year 2023-24 (FY24)

The sharp rally in the markets this year has come on the back of price-to-earnings (P/E) expansion even as analysts have scaled back the growth projections. Sample this: In June 2022, the aggregate profit pool for top 600 companies was projected to touch Rs 13.2 trillion for the ongoing financial year 2023-24 (FY24). 

A year ago, the combined market capitalisation (m-cap) of these companies was Rs 216 trillion, which has now grown to Rs 275 trillion. 

However, the earnings estimates have been downgraded by 4 per cent. This is due to lowering of earnings estimates for Reliance and companies in the metals, telecom, healthcare and IT sector. As a result, the domestic market has become 33 per cent more expensive on a P/E basis compared to the year-ago level. 

“The rapid expansion in m-cap over the past three months is likely due to a sharp decline in ‘equity risk premium’ and benign ‘risk free rate’ environment,” observe ICICI Securities’ equity strategists Vinod Karki and Niraj Karnani in a note. They add that the earnings downgrade, “appears reasonable, given the shocks such as the massive quantitative tightening cycle, Russia-Ukraine war and banking crisis in the developed world.” 

Analysts say that further downgrades can’t be ruled out if the June 2023 quarter (Q1FY24) earnings growth fails to meet expectations. This could put the red-hot Indian markets under pressure.