‘Markets will now track underlying earnings growth’

The benchmark Nifty and Sensex have made fresh record highs. Valuations right now are neither expensive nor cheap but in line with long-term averages, says GAUTAM DUGGAD, head of research, institutional equities, Motilal Oswal Financial Services, in conversation with Sundar Sethuraman. Edited excerpts:

Have you lowered the earnings estimates for 2022-23 (FY23) and 202324 (FY24)? Will there be further cuts?

We haven’t lowered our earnings estimates. We have raised our FY23 estimates Nifty earnings per share (EPS) by 2.5 per cent to ~837, from the earlier ~817, due to notable earnings upgrades in State

Bank of India, Axis Bank, and

Coal India. We now expect the Nifty EPS to grow 14 per cent and 19 per cent in FY23 and FY24, respectively.

Do you think valuations are very expensive right now?

We believe the valuations at

20.5x one-year forward price-to-earnings for the Nifty50 Index are not exorbitantly expensive. But they aren’t cheap either. They are in line with a long-period average of 19.5-20x.

What is crucial for these valuations to sustain is the consistent delivery of earnings over the next few years. Corporate earnings have already reverted after a decade of lost growth between 2009-10 and 2019-20. Nifty earnings were at 6.5 per cent compound annual growth rate during the decade. Subsequently, they went up 20 per cent and 40 per cent in 2020-21 and 2021-22 (FY22), respectively, and are now up 14 per cent in the first half of FY23.

What are the key risks for the market?

A continued elevated inflation print presents a downside risk to the market as it can lead to higher interest rates which don’t augur well for equity valuations. Moreover, the gross domestic product growth rate is expected to soften in the second half of FY23 in the 4.5-5 per cent band. Aside from a slightly medium-term viewpoint, the 2024 election outcome will also have repercussions for the market.

What is your Sensex target for end-2023?

We do not have index-level targets, but we expect the markets to now track underlying earnings growth and do not expect any material valuation rerating in the near term.

Which are the sectors/themes you see value in?

We have an overweight stance on banking, financial services and insurance (BFSI), information technology (IT), and consumption. BFSI is leading market earnings and is expected to contribute 60 per cent of the incremental Nifty earnings in FY23. Structural tailwinds for BFSI, such as good pick-up in the credit growth cycle and a continued low credit cost environment, make for a heady cocktail for the sector.

The sector hasn’t seen any meaningful cut in revenue growth guidance, notwithstanding the prevailing challenging global growth context.

The supply situation has improved on the hiring front, offering respite to margins sequentially. As always, the sector’s balance sheet and free cash flow characteristics remain supreme, facilitating continued capital returns in the form of dividends and payouts.

The consumer discretionary space provides a good opportunity to participate in rising disposable incomes and low penetration in many of the discretionary categories like quick-service restaurant, jewellery, and footwear.

Isn’t the ‘buy private banks’ trade overcrowded?

We see further value-creation opportunities in private banks.

The BFSI earnings in Nifty have already gone up from ~45,000 crore in 2017-18 to ~1.5 trillion in FY22. We expect them to deliver earnings of ~2.06 trillion in FY23.

Should one wait for further correction in IT stocks?

Timing the market and the sector for an absolute bottom is impossible. IT offers a well-demonstrated track record of consistent wealth creation over the past two decades despite facing a multitude of challenges from Y2K, 9/11, global financial crisis in 2009, taper tantrum in 2013, and the Covid-19 pandemic in 2020.

Despite near-term headwinds on global growth slowdown, we expect IT spending to remain resilient and the Indian IT sector to benefit from a structural uptrend in tech spending. We prefer large-cap IT and have Infosys, Tata Consultancy Services, and rebadged HCLTECH in our model portfolio.

The broader market has underperformed, especially smallcaps. Is that a better pocket to invest in?

“WE BELIEVE THE VALUATION SAT 20.5X ONE-YEAR FORWARD PRICETO-EARNINGS FOR THE NIFTY50 INDEX ARE NOT EXORBITANTLY EXPENSIVE. BUT THEY AREN’T CHEAP EITHER”

Small-caps have undergone massive underperformance. The NSE Smallcap 100 Index is up just 15 per cent since December 2017. They are now trading at a good 25 per cent discount to the Nifty and offer good value from a top-down perspective. It is always a bottom-up approach that is prudent to adopt in small-cap investing. We expect smallcaps across sectors, where business leadership and balance sheet/cash flow quality are intact, to catch up.