From 25,000 levels to 60,000 within 18 months. Do you think the index has run too fast too soon?
The world is awash with liquidity, which is chasing growth. India is a high-growth market. Indian corporates have superior earnings quality, and they are performing well on all the parameters. The earnings outlook has improved, which has led to rerating of many sectors in the past year. Also, the macroeconomic outlook is better. India’s current account deficit, foreign exchange reserves, liquidity in the banking system, interest rates and inflation are indicating a stable economic outlook. So, the index upmove is backed by strong reasons.
Do you think with a trailing one-year price-earnings multiple of 32 and price-to-book of over 4, the Nifty valuations are justified?
The market ignores the past, so trailing multiples are not the right indicators for a forward-looking market. Due to issues like banks’ non-performing assets problem, demonetization, GST, and Covid in the last five years, the Nifty’s earnings remain subdued. That’s why there was a discrepancy between the actual EPS (earnings per share) growth and what the street expected at the start of each year. But due to a stable macro outlook and ample liquidity, we believe that earnings would be better this time.
On a one-year forward basis, the Nifty is trading 21 times FY23 earnings. The historical average is around 17 times so it’s getting a higher premium, but there are solid reasons for this.
What are the reasons for the Nifty premium?
The earnings outlook for many sectors has improved a lot. In the past one year, sectors like telecom, banking, real estate and metals got rerated by the street. Banking and financials, with a weight of 38 per cent in the Nifty index, holds the key for the index EPS growth. Due to normalisation of the provisioning cycle, banks will register a healthy profit growth. Based on the street estimate, this sector will grow at 23-24 per cent compounded annual growth rate for the next three years.
Metal companies had a phenomenal run, and they were responsible for the improvement in banks’ balance sheet, with a massive deleveraging exercise initiated by them in the past one year.
We have also seen healthy recovery in the real estate sector mainly due to low interest rates and stamp duty waiver announced by several state governments. Telecom is another sector that got rerated and now there are only three players left, which gives earning visibility to the street.
What are the patterns that you see in the current market?
Although in FY20, Nifty companies contributed 63 per cent of the overall corporate profits, the Nifty Small-cap index beat the Nifty and the Nifty Mid-cap indices hands down in FY21. From the lows of March 2020, the returns from the Nifty, Mid-cap and Small-cap indices were 140 per cent, 179 per cent and 226 per cent, respectively, until mid-September. Year-to-date, too, the Small-caps index outperformed the other indices.
Usually, small-caps outperform large-caps when there are signs of healthy recovery in the economy. If the stock price is an indication for the economy, then small-caps are hinting at good economic recovery. Apart from focusing on the domestic economy, the Nifty companies are also paying attention to the overseas markets. Now, over 25 per cent of the Nifty revenues come from overseas markets.
What else is in focus?
Corporate deleveraging has gained ground. A lean balance sheet is the new mantra and is well-reflected in reducing net debt/equity for the Nifty companies. From FY19 to FY21, net debt/equity has reduced from 0.7 to 0.6. With strong tailwinds for metal firms, this should reduce further this year.
What is your advice to retail investors on asset allocation?
Asset allocation depends on age, income and risk profile. There is no thumb rule, as every individual must make his own goals, depending on age and income. A younger person should invest more in equities, while an aged one should care more for return of capital than return on capital.