Allow them some time to enjoy their space in the sun: Manish Chokhani on slowdown in earnings of small-, mid-cap firms

Manish Chokhani on the five key risks he sees for the Indian market

On earnings growth in the mid- and small-cap space, Manish Chokhani, Director, Enam Holdings notes that he wouldn't call it a contraction but states that there has been a slowdown. But despite a slowdown, there continues to be drivers for the growth in the segment.

“Earnings have certainly slowed down,” Chokhani said, noting that India’s Goods and Services Tax (GST) collections remain low given that nearly 70 percent of GDP is taxable under GST. This, he noted, limits the government’s ability to boost public spending.

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Apart from taxation, Chokhani noted that there is a need for reforms for sustained growth growth. One such suggestion was disinvestment in non-core businesses. "It’s not the government’s job to be running businesses," he said. "If they can get three, four, five times the book value on their assets, which today would be 30 or 40 multiples, it’s an opportunity to take that capital, invest in new assets, and then recycle those returns at compounded rates of 30-40 percent." Chokhani added that such reforms have been overlooked, even during the bull market, when government asset sales would have been particularly lucrative.

“The regulatory cholesterol, the judicial reforms—these are all holding back industry from becoming global in size,” he said. He noted that due to bureaucratic hurdles, companies often prefer to build multiple small plants rather than investing in large-scale facilities that could yield cost efficiencies. “You can’t achieve economies of scale when you're setting up five plants instead of one mega plant, just because of the regulatory and labour union challenges,” he said.

On exports, Chokhani noted that there is a need for a push for Free Trade Agreements (FTAs), along with the potential in renewable energy, nuclear, and solar sectors. He explained that aligning investments with these trends could help Indian companies stay competitive globally and diversify their revenue sources.

He added "our trend line earning trajectory is 15 percent in a capitalist society", explaining that sustainable returns often align closer to 13-15 percent annually. “We come back to this 13-15% type earning trajectory, which typically gives us a double every five years. It’s the norm, and I don’t think we are breaking that norm anytime soon, especially as we financialise and formalise further.”

Chokhani added,  “Today, these small and mid-cap companies are in a cyclical upturn where you're making 50-60% compounded returns for a year or two, and then you fall back." He said that this cycle doesn’t indicate a long-term earnings contraction. "It's the same analogy as the 2005-2008 bull market, where real estate, capital goods, and power sectors had banner years and then went through a long dormancy. Allow them some time to enjoy their space in the sun."

Chokhani noted that seventy-five percent of the world’s wealth has been created by maybe 100 companies, “Real mega wealth creation, the kind that’s sustainable, happens there—it’s not every small company becoming a midcap, nor every midcap growing to a large cap,” he said.

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