Earnings decline slows Nifty run after rallying nearly 50% from March lows

Index has rallied close to 50% from its March lows even as underlying EPS has fallen about 20%

The equity markets have hit a hard ceiling after bouncing nearly 50 per cent from the March 20 lows.

And the reason could be a steady decline in corporate earnings after they hit a high in the December quarter following the cut in corporate income tax.

From its lows in March this year to its high early this month, the benchmark Nifty50 index rallied nearly 52 per cent. That, however, coincided with a steady decline in the index’s underlying earnings per share (EPS) as corporate revenue contracted during the March and June quarters.

The index EPS, on a trailing 12-month basis, was down nearly 22 per cent in the past nine months from around Rs 450 in the last week of January to around Rs 350 now. 

Analysts say this made it tough for the bulls to justify the ever expanding price to earnings (P/E) multiple for the index companies. The Nifty50 trailing P/E multiple nearly doubled from 17.2x at its lowest point in March to a record high of 33.3x on September 16.

Historically the movement in the Nifty has closely followed the trajectory of its underlying EPS.

“The market has run up too fast and too soon, which has created a fatigue among investors in the absence of earnings growth. At its recent peak, the indices were more expensive than even at the height of the dotcom boom in 2000 or the pre-Lehman (collapse) rally in 2007,” said Dhananjay Sinha, head, research, Systematix Institutional Equity.

In the past 10 years, the Nifty50 trailing P/E multiple has been, on average, 22x. 

Analysts say that the correction will restore some balance between stock prices and the underlying economic and corporate fundamentals. 

“The rally was always on a slippery wicket as it assumed a V-shaped recovery in corporate earnings in the second half of the current financial year. The events in past few weeks, including the growing count of Covid-19 cases, has forced investors to temper their expectations, leading to profit booking at higher levels,” said G Chokkalingam, founder and managing director, Equinomics Research & Advisory Services.

Optimism was clearly visible in market capitalisation. The combined market capitalisation of all listed companies reached nearly Rs 1.62 trillion, nearly Rs 3 trillion higher than that on the day the central government announced economic lockdown on March 22. Market capitalisation has declined to around Rs 1.49 trillion.

“The markets believed that corporate earnings will be higher in the post-Covid-19 environment than prior to it. This is tough to justify in the current environment,” said Chokkalingam.

Analysts expect an expansion in corporate earnings and those of Nifty50 companies in the next three quarters on a sequential basis but it may not be enough to fill the hole created by the pandemic. For example, Sinha expects a 15 per cent sequential rise in the Nifty50 EPS by the end of the March 21 earnings season from the current levels. “We expect the Nifty EPS to expand to Rs 396 by the end of the March quarter from around Rs 350 now and around Rs 440 before the beginning of the pandemic,” said Sinha.

This will translate into an index one-year forward P/E multiple of 27x, which will still be nearly 22 per cent higher than the index average valuation in the past 10 years.

Anyway on a long-term basis, stock prices have been running ahead of corporate earnings, leading to a steady expansion in the P/E multiple. 

At its current level, the index EPS is similar to the level last seen in December 2013 but the index is up nearly 80 per cent during the period.