End of earnings downgrades

Global uncertainties, rupee depreciation, economic slowdown led to an almost 8% downgrades over the last one year in Sensex earnings

The initial result preview published by the research houses suggest that the process of earnings downgrades is bottoming out.

About a year back the analysts were expecting the FY13 earnings for the Sensex at about Rs 1,370, which now stands at about Rs 1,260.
Combination of global uncertainties, rupee depreciation and slowdown in Indian economy led to an almost 8% downgrades over the last one year in Sensex earnings for the financial year 2013.

However the experts now believes that there is limited scope for the further downgrades. "The pace of downgrade has slowed down considerably. In the last 9 months, Sensex EPS downgrade is less than 4%, and in the last 3 months, there is actually a miniscule upgrade. Equally important, if not more, FY14 earnings estimates have not seen any meaningful downgrade in the last 6 months. Clearly, the last two quarters are some evidence of a possible end to the earnings downgrade cycle" Rajat Rajgarhia, director of research at Motilal Oswal Securities in a recent strategy note.

On the positive side, the analysts are attributing this to the improvement in the sentiments led by the sudden gush of reforms initiated by the government.

Additionally the lower crude oil prices and other commodity prices, appreciation of the rupee and hope of rate cut in the coming months has helped in arresting the negative sentiments thus helping the downgrade cycle reverse.

More importantly the analysts are expecting a strong earnings growth in the financial year 2014 to about Rs 1400 for the Sensex. Importantly, the analysts believes that the FY14 earnings are less susceptible compared to FY13 earnings given the underlying improvement in the economy and the benefits of the expected rate cut and improvement in the investment cycle next year.

Improvement in the earnings is critical after the lull of almost 2 years and their impact on the share prices. In fact higher earnings growth next year is one of the catalysts for the rally in the markets to sustain in the medium term. The valuations of the Sensex based on the FY14 estimated earnings works out to about 13.5 times which is good from the historical perspective.

The average one year forward price to earnings ratio for the Sensex in the last ten year is at about 15 times. This means that despite the rally in the markets the Sensex at current trades below its long term average.