The latest earnings season has started on a very buoyant note, led by some IT companies. In line with the high speed macro indicators, most brokerages have upgraded their earnings estimates in past one month. The present estimates are building in a very strong earnings recovery over FY22-FY23. The estimates for the current year FY21 have also been upgraded sharply from a contraction of 5% to 12% to a growth of 5% to 12%. Currently, the market is estimating an earnings growth of 24% to 38% in FY22 and another 18% to 22% growth in FY23.
It is important to note that these estimates assume GDP growth of -7% to -7.5% in FY21; 9% to10% in FY22 and 4 to 5.5% in FY23; interest rate bottoming in FY21 and elevated inflation of 5 to 6% over FY22 and FY23.
This implies less than 3% CAGR of GDP over three year period of FY20-FY23. Whereas, the present estimates imply ~19% CAGR in Nifty EPS over FY20-FY23. Apparently, there is disconnect between the macro forecast and earnings forecast. In past two decades at least, there is no precedence of such strong earnings growth with a dismal economic growth.
Furthermore, the estimates assume a strong recovery in earnings of financials and materials, from a very low base. Just to give a sense, Kotak Institutional Research estimates 473% (yoy) growth in Banks PAT and 860% rise in Metal’s PAT in Q3FY21. Construction Material (86%) is the third fastest growth forecasted. These three sectors probably have the strongest correlation with the macroeconomic growth and stability. Next 9months may be a case of low base effect, but with 3% economic growth, higher interest and inflation, it is tough to fathom these sector continue clocking sustainable high growth.
So in all likelihood the earnings estimates for FY22 and FY23 will fall in due course, as has been the case historically. Credit Suisse highlighted in one of their December report that EPS estimates fall 10 to35% from the level that is first estimated.
In my view, therefore, it would not be advisable to consider aggregate earnings as a key factor for investment decision. Better would be focus on the companies where sustainable earning growth visibility is very high. Of course these stocks will also fall in case of a broader market correction, but the chances of their bounce back would be much higher.
I shall therefore remain agnostic to sectors and size of companies. I would rather focus on individual companies for investment. Sustainability of growth would be my key consideration in selecting the company.