Are markets undervaluing long term earnings growth?

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Are markets undervaluing long term earnings growth?

ICICI Securities has come out with its report on the Indian market. The research firm recommends 7 stocks for investment.

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ICICI Securities has come out with its report on the Indian market. The research firm recommends 7 stocks for investment.

What's in the Price?

• Embedded in the stock price and market multiples are assumptions about long term earnings growth prospects, value and equity risk, which are not explicitly articulated. After accounting for the value derived from current earnings and growth in consensus earnings for the next two years, our 'What's in the Price?' analysis reverse engineers to demystify and articulate the market implied long term growth value (MILTGV) and market implied long term earnings growth (MILTG) embedded in the stock price and market multiples, to provide better and insightful conclusions of warranted value.
• Our proprietary 'Market Implied Long Term Growth Value' (MILTGV) matrix, ranks the Niftyfifty stocks based on a aggregated score for (a) Current MILTGV ratio; (b) consistency of MILTGV ratio over the last two years; and (c) expected long term growth opportunities/threats, to identify stocks that are attractively priced. Based on the aggregated scores and our bottoms up research, the most attractive stocks (top three) include, Axis Bank, SBI and Tata Steel and most challenging stocks (bottom three) include Hindalco, DLF and Reliance Power. 
• For investors with focus on long term earnings growth, Punjab National Bank and Sterlite are attractive as their MILTG are not only incompatible with their long term earning growth outlook but are also at a significant discount to their historical averages. For investors with
  focus on consistent performers, Siemens, HDFC and ITC stand out.
• Assuming the short term earnings outlook and current MILTGV ratio to persist, stocks are expected to appreciate on the back of equity risk reduction, if the consensus view on policy rate decline fructifies.

Investment Thesis - most attractive stocks

Axis Bank : Market attributes 63.6 percent of value to sustainability of current earnings (6.3 PE/1.3 PB) and the rest (3.6 PE/0.5 PB) to growth in short term (24.7 Percent) and long term (11.7 percent) earnings. Implicit in the MILTGV is a MILTG of 4.2 percent. Unlike HDFC Bank, the MILTGV ratio has been decreasing due to a volatile stock price and worries around short term earnings suggesting market focus on short term performance.. Assuming that current level of short term earnings outlook to persist, we feel that the long term benefits from margin improvements and/or credit growth in business are not adequately reflected in the low MILTGV ratio, providing potential upside in the stock through MILTGV ratio improvement002E.

SBI : Market attributes 72.1 percent of value to sustainability of current earnings (6.6 PE/1.1 PB) and the rest (2.6 PE/0.2 PB) to growth in short term (33.6 percent) and long term (-5.6 percent) earnings. Implicit in the MILTGV is a MILTG of 1.9 percent.. Over the last eight quarters, the MILTGV ratio has been decreasing with the volatile stock price and a declining short term earnings, suggesting excessive focus on the short term prospects and less on long term earnings growth from margin improvements and/or growth in business due to concerns around asset quality, loan loss and pension provisioning. Assuming that short term earning growth outlook to persist, we expect potential upside for the stock from improvements in MILTGV ratio once the worries subside.

Tata Steel : Market attributes no value to current earnings, 110.5% (4.0 PE) to sustainability of short term earnings and -10.5% (-0.4 PE) to long term earnings . Implicit in the MILTGV is a MILTG of 0.3%. Due to acute pessimism in the stock, the stock price declined more steeply than the shortterm earnings, resulting in a negative MILTGV ratio. Even after factoring in the long-term worries around (a) overseas operations and (b) pension liabilities, we feel that the negative MILTGV ratio for the long term earnings growth opportunities is unjustified. Assuming that the short term earnings outlook would remain at the existing levels, the stock would move up with improvement in the MILTGV ratio.

Hindalco : Market attributes 80.2 percent of value to sustainability of current earnings (6.2 PE) and the rest (1.5 PE) to growth in short term (10.7 percent) and long term (9.1 percent) earnings. Implicit in the MILTGV is a MILTG of 4.5 percent. In the last three quarters, stock price has declined more steeply relative to short term earnings resulting in a rapid fall of MILTGV ratio to 9%. Long term worries around disclosures and high input costs justifies the current low MILTGV ratio. Assuming the short term earnings growth outlook to remain at their existing levels, further downside in MILTGV ratio cannot be ruled out if long term concerns persist, implying further downside to the stock.

DLF : Market attributes 32.6 percent of value to sustainability of current earnings (6.2 PE) and the rest (12.8 PE) to growth in short term (4.9 percent) and long term (62.5 percent) earnings. Implicit in the MILTGV is a MILTG of 11.0 percent. Despite a steep decline in stock prices and continuous earnings downgrade, the MILTGV ratio remained consistently high (>60 percent) in most quarters. Assuming that the current level of short term earnings growth outlook persists and the long term headwinds relating to debt and demand stays their course, the company, moving forward, may not be able to sustain such high MILTGV ratio, implying potential downside for the stock.

Reliance Power : Market attributes no value to current earnings, 32.8% (6.4 PE) to sustainability of short term earnings and 67.2% (13.1 PE) to long term earnings . Implicit in the MILTGV is a MILTG of 10.0%. The stock performance and the short term earnings outlook have deteriorated over the last three quarters, thereby reducing the MILTGV ratio to ~68%, which by itself is quite high considering that the business is in early stage of development and given the headwinds for the sector. Assuming that the current level of short term earnings outlook would persist and given the high MILTGV ratio, potential downside for the stock exists.

Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

To read the full report click on the attachment