Nifty under Modi: What investors have learnt so far (Hint: respect earnings)
As Nifty scales new highs and valuation comfort in the market wanes, investors should focus solely on the earnings trajectory to pick the winners for the remainder of Modi's tenure.
Since the NDA’s landslide win in the 2014 polls, the Nifty Index has risen 34 percent in absolute terms, and 10.3 percent annually compounded. That may seem modest at first glance, but the breadth of the rally shows enough stocks that delivered eye-popping returns during the same period.
Earnings for the Nifty as a whole have been flat and that makes the index look expensive. But a closer look at earnings growth and share price performance of individual Nifty companies underscores the fact that stock prices are slaves to earnings in the long run.
The following graphs tell the story.
Exhibit 1 – Nifty stocks with returns greater than 100 percent over the past three years.
For example, an investment of Rs 1 lakh in the stock of Eicher Motors when Modi took office would have given an investor over Rs 4.5 lakh today. The company’s earnings have also grown 3 times over this period. Eicher is not the sole stock where the financial performance was well rewarded by the market. Indiabulls Housing and Maruti Suzuki grabbed the second and third positions, respectively. Discretionary consumption clearly benefited in the first three years of the Modi era. The top ten gainers list also includes other notable discretionary consumption names like Asian Paints. The first lesson learnt was that stock prices follow earnings.
Exhibit 2 – Nifty stocks with returns at least two times higher than the index return over the past three years.
Interestingly, for all these leading discretionary consumption names, while the earnings growth was robust, the stock return far exceeded the earnings growth, thereby indicating multiple re-rating. Smart investors clearly rode on companies where there was earnings visibility, thus rendering them expensive, apparently. However, as long as the earnings story remained intact, valuations did not stand in the way of stock performance. This is the second lesson learnt – do not worry too much about valuation if there is earnings growth.
The winners list includes a couple of stocks that benefitted from policy changes – BPCL and IOC. The deregulation of most of the petroleum products led to sharp earnings improvement and re-rating of the sector. In fact, unlike discretionary consumption, for the downstream oil companies, earnings growth has outpaced stock performance. Hence, even after the sharp rally, the stocks look reasonably valued on a relative basis.
The other pocket which benefitted in the first three years of Modi Sarkar are the savvy private banks that steered clear of the NPA mess that majority of the public banking entities were faced with. The private banking sector will continue to hog the limelight too, albeit the seemingly expensive valuations, as companies aim to grab market share from their comparatively weaker public sector counterparts. The banks that benefitted the most since the past three years were Yes Bank, IndusInd Bank, and Kotak Mahindra Bank.
Exhibit 3 – Nifty stocks with negative returns over the past three years
Turning to the laggards, which mostly included companies affected by international aspects, earnings disappointment had a major role to play. The third lesson to keep in mind is that though companies with strong global linkages (either because of commodity prices or export-oriented businesses) may witness a sharp surge in earnings (which, in turn, remain contingent on numerous global factors) from time to time, subject to a good financial performance, chances of volatile movements and correction of multiples cannot be ignored. Therefore, going forward, strong domestic driven businesses will enjoy a premium over global businesses.
Interestingly enough, although there have been big winners within the Nifty – both in terms of earnings and price performance -- the same hasn’t impacted blended index earnings as the share of the market capitalization of the winners, at 38 percent, is much less than the losers.
As Nifty scales new highs and valuation comfort in the market wanes, investors should focus solely on the earnings trajectory to pick the winners for the remainder of Modi's tenure.Full coverage: Three years of Modi government