Each of the last four Diwalis have seen Sensex substantially higher
01-Nov-2006 •Value Research
Indian investors are getting used to some fantastically happy Diwalis. The Diwali-to-Diwali gains for the last few years have been wonderful. Each of the last four Diwalis have seen the BSE Sensex substantially higher than the previous year, with this year's Diwali being the best. Diwali 2006 saw the Sensex a heartening 61 per cent up from the previous year, despite the high base and the collapse in June.
Normally, when a strong bull run ends with a 25+ per cent loss in a major index, then it is clear that things are going to be bad for a while. However, for the first time ever, the Indian stock markets have defied this rule and are now charging ahead with renewed vigour.
And the engine for this growth is not something as untrustable as expectations of future growth but solid, unprecedented growth in the profitability and performance of corporate India. Indian companies haven't had such a wonderful Diwali in living memory. As we go to press, quarterly results of about 1,500 companies are available to us. These companies have shown a remarkable increase in their profitability. Overall, their turnovers are up 31 per cent and profits an amazing 46 per cent. In all, these companies have made profits of Rs 51,000 crore on a turnover of just over Rs 500,000 crore. Add to this profit the depreciation of Rs 13,000 crore and we have a humongous Rs 64,000 crore of cash being generated in these three months.
Mind you, this bottom-line growth of 46 per cent is just the average - there are plenty of companies whose profits have grown much more. Growth of 50, 60 or 70 per cent is not uncommon. Even large companies have delivered eye-popping numbers. HLL, whom no one has listed as a high-growth prospect for years now has made 59 per cent more money than it made in the corresponding quarter last year, taking its profits for the quarter from Rs 326 crore to Rs 521 crore.
But the good news doesn't end here. These numbers are not skewed by some particular sector or type of company doing well. Instead, companies spread across a broad spectrum of industries are showing outstanding results. Moreover the internal balance of these results is refreshingly healthy. The top-line has grown very strongly, and the bottom-line has grown even more strongly. This indicates that this story is not about to end here. The growth is real and has deep roots.
While these corporate results have provided the financial push for the stock markets' gains, there's a psychological push as well. Indian companies have an increasingly high-visibility global profile. Tata Steel's proposed acquisition of the Anglo-Dutch steelmaker Corus is the largest ever done overseas by an Indian company. Not only is it the largest in size, but the Corus deal has had a huge impact on the mood on the street. 'India Shining' sounds very far from sounding like the joke that it did after the general elections last year.
The good news is there not just on the corporate front but the broad underlying economic scenario is also looking comfortable. For what seems to be the umpteenth time, rural India has enjoyed a good monsoon. This should definitely boost rural demand for goods over the next few months. Urban personal disposable incomes are seeing fantastic growth as employers vie to out-hire each other (and with the BPO industry). The high income growth across urban and rural India has meant that far more than the other so-called emerging economies, India's growth is led by domestic demand. This provides our growth story with at least a bit of a cushion from a slow down in the US.
Other macro indicators are also positive. Credit off-take from banks continues to be robust despite higher interest rates. There's also a spate of IPOs that are lined up by companies in different industries. The appetite for fresh debt as well as capital underscores the stream of announcements about fresh new ventures that corporate India is rushing into. Given the numbers that are coming out, it is clear that the economy will grow at greater than 8 per cent in the whole year. It is also clear that one can reasonably expect the government to be able to keep its budget deficit in shape because the growth in tax revenue is more robust than it has been for years. For example, the 1600 companies mentioned above are paying 47 per cent more tax than the comparable quarter last year. Overall, direct taxes are reported to be up by about 40 per cent.
As investors, the one bugbear we keep hearing about is that Indian stocks are getting overpriced. Various pundits have opined that despite everything, the current bull run is largely fuelled by FII money and no matter how good the fundamentals, FII investment could dry up if Indian stocks become overpriced. And, goes the story, Indian stocks must be close to getting overpriced because the Sensex is the most overpriced of the various emerging markets indices.
While these things are true at a superficial level, it is useful to look at the supposed expensiveness of the markets in a little more detail. The Sensex P/E may be at a high 21, but if one removes just four companies- Reliance Communications, Ranbaxy, Infosys and Bharti Airtel, then the P/E drops to 17.5. So what we observe is that a handful of exceptional, high-growth companies have a high P/E-which is as it should be-and most others are still reasonably priced. Of all the kinds of averages that are bandied about, average P/E is the least useful if one doesn't look at the composition of that average. Smart investors, whether foreign or Indian, buy individual stocks, not averages. If an average is skewed because of a handful of high-weightage outliers, then drawing any conclusion from it is downright dangerous. So are we saying that there are no warning signs at all and that everything is as it should be? Not quite. One crucial positive factor that could prove to be ephemeral are low oil prices. While oil prices are low today, the Middle East has clearly entered a more-than-normally unstable state during this year and over the medium term, it can almost be guaranteed that disruptive events will take place in this part of the world. Domestically, rampaging asset prices are probably the biggest threat. The real estate price boom is now clearly unhealthy and shows little sign of abating. How manageable the side-effects of this bubble collapsing will depend on when it happens and whether it collapses under its own weight or whether it's accompanied by other economic troubles.
In balance, it is a great time to be investing in the Indian economy but that doesn't mean that one can afford to do so blindly. This isn't an easy decision to make when the stockmarkets are at an all time high, but a cautious and studied approach can still bring gains to investors.