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| Earnings upgrade to deliver higher returns |
| Jitendra Kumar Gupta / Mumbai Jun 11, 2010, 00:35 IST |
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Analysts have started increasing their estimates for the current year due to improving demand and lower costs
With the results season almost over, analysts have begun taking stock of their earnings estimates for the current year and thereafter. Backed by strong earnings growth in the March quarter, many have started upgrading their estimates. An improving earnings outlook and reasonable valuations, coupled with reasonably strong domestic consumption, could help earn good returns from Indian equities, both in the interim and long run.
Strong growth expected
Importantly, analysts are now expecting higher earnings per share (EPS) for the Sensex in 2010-11, with some of them having already raised their earnings estimates. According to Motilal Oswal Securities, revenues of the Sensex’s 30 companies grew by 27 per cent for the quarter ended March, while growth in net profits was stronger at 38 per cent. This is also why the brokerage has upgraded its 2010-11 Sensex earnings by three per cent to Rs 1,078, a 30.5 per cent increase over 2009-10’s estimated earnings of Rs 826.
Scope for more upgrades
While the improvement in earnings is positive, a sustainable trend will make valuations attractive.
For now, the consensus estimates suggest analysts are expecting 22.5 per cent growth in 2010-11 and 18 per cent growth in 2011-12, which is very good. Notably, analysts see scope for further earnings upgrades, which will mean higher Sensex EPS than expected currently. “In many of the industries, the raw material prices have come down, which will add to the net profits of these companies,” says Murali Krishnan, director, research, Ambit Capital.
“We will see more upgradations in Sensex earnings happening in this quarter and the next, since the profits are going to be better than expected. In general, we are expecting plus-30 per cent growth in net profit over the next two quarters,” asserts Tarun Sisodia, Head of Research, Anand Rathi Financial Services.
On the other hand, while Tridib Pathak, senior director — equities at IDFC Mutual Fund, says the March quarter earnings haven’t supported the earnings upgrades cycle, he believes “As we go forward, due to economic growth momentum continuing and top line growth remaining strong and with cost pressures under control, we can expect earnings upgrade to happen over two-three quarters.”
Downside cushion
The Indian equity markets have been volatile and corrected marginally in the recent past on account of global issues. However, if the strong earnings momentum continues, the markets’ valuations will look attractive, which will provide cushion in the downside. For instance, analysis of the past 15 years’ data showed the Sensex had traded, on an average, at 14 times its one-year forward earnings.
Presently, when the Sensex is trading at 15 times its one-year forward earnings, it suggests the valuations are not expensive vis-à-vis the historical average, even after their doubling in the past 15 months. Even during the severe market correction during 2008 and early 2009, the Sensex did not trade below 11 times its one-year forward earnings (See chart, Sensex: Forward PE).
Strategies & picks
Research houses have put the one-year Sensex target in the range of 18,000-22,000, reasonable if one considers the price-to-earnings (PE) multiple is 14-17 times of 2011-12 estimated earnings. Meanwhile, though the markets are trading at reasonable valuations and there are expectations of further upgradations in earnings, investors might have to live with high volatility in the near term. The European crisis and risk aversion among global investors are some key concerns.
Analysts suggest investors should not increase their cash levels merely due to the global concerns. And, instead, use the correction in the markets to add good companies, preferably with less debt and those catering to the domestic market. The confidence stems from India’s consumption story, far stronger than some of the major global economies, where issues relating to demand and sovereign risk persist. Among the top picks, the research houses prefer to include stocks like SBI, HDFC Bank, L&T, BHEL, ITC, M&M and Reliance Industries.
A few also suggest that focusing of stocks that stand to gain from the global slowdown could help outperform the markets. They cite the example of oil marketing companies that stand to gain from a global slowdown, as it is likely to lead to lower crude oil prices.
For investors with a higher risk appetite, they could consider fundamentally sound and well-managed companies, especially leaders in their respective segments. Companies in the infrastructure (construction and project-owning) segment such as IVRCL Infra and Voltas are among preferred picks. Similarly, stocks in banking, pharma and information technology (aided by increasing outsourcing) could deliver good returns.
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