Last Updated : Nov 21, 2018 05:02 PM IST | Source:

Living the ‘Stockdale paradox’: Earnings downgrades outpace upgrades in Q2

Out of 230 widely covered companies, 77 beat estimates, 88 missed estimates, and 64 reported earnings in line in Q2.

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Investors are eagerly waiting for a bounce back in earnings, but like the ‘Stockdale paradox’, best illustrated in the book ‘Good to Great’, optimism around earnings recovery belied expectations once again resulting in the quarterly earnings downgrade of 5 percent during Q2FY19 (3 percent downgrade in Q1FY19), ICICI Securities said in a report.

The book Good to Great explains the Stockdale paradox as, "Retain faith that you will prevail in the end, regardless of the difficulties, and at the same time confront the most brutal facts of your current reality, whatever they might be."

The crude reality in today's market is that earnings recovery has not been matching the optimism on the Street.

Out of 230 widely covered companies, 77 beat estimates, and 88 missed estimates and 64 reported earnings in line in Q2. The threshold for beats and misses is +/-5 percent.


The Nifty50 FF (free float) PAT growth is 8 percent for Q2FY19 thereby resulting in H1 growth of 6 percent as compared to FY19 consensus expectation of about 19 percent which raises the hurdle rate for H2FY19 considerably and enhances the prospects of more downgrades going ahead, said the ICICI Securities report.

Focus on sustainability and recovery in earnings

As much as 54 percent of the earnings growth in FY20E is expected to come from banks. Significant base effect and normalisation of earnings for corporate banks which is aided by peaking NPA cycle and improving credit growth, telecom and Tata Motors will probably pull earnings to about 18-20 percent growth in FY20E.

Although, it raises doubts about the longer-term sustainability of the growth. For sustaining high growth, the key determinants will be revival in private capex cycle, credit growth, adequate liquidity, stable policy and low real interest rates.

Metals, energy and IT will see the highest fall in their contribution towards FY20E earnings growth as compared to FY19E. Pharma growth is expected to be robust but recovery in US market will be the key.

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Nifty target cut:

Since the beginning of FY19, the 1-year rolled forward EPS for the Nifty50 has moved up by a mere 2 percent due to earnings downgrade. Despite weak earnings growth for the past six years (5 percent CAGR). The Nifty50 index has risen at a CAGR of ~13 percent due to expanding valuation multiples for stocks.

However, over the past one year, the environment for rising equity valuations is deteriorating with global liquidity getting tighter, higher bond yields, macro headwinds, and prospects of slowing global growth from FY20 onwards.

We expect incremental downgrades to our base Nifty50 earnings estimate thereby resulting in a CAGR of 15.5 percent during FY19-21 and cut our target multiple to 17.1x (+ 0.4 s.d.) to arrive at our December 2019 target of 11,800.
First Published on Nov 21, 2018 02:15 pm
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