May 2019: Investors should look at growth rates after adjusting for inflation

The Nifty is up nearly 10% in this calendar year and has been steadily climbing apart from a brief blip before the election results. With the election results out of the way, there is a sense of buoyancy. Stock markets like decisive mandates and continuity of policy, but these factors are temporary. Long term returns from equity markets are dependent largely on long term corporate performance and the valuations at the point of purchase.

Over the past 5 years (FY2014-19) the median company currently in the Nifty, has grown revenues at 10.6% pa and profits at 10.1% pa. This compares with a revenue growth of 18.3% pa and profit growth of 20.8% pa in the previous 5 year period (FY2009-14). One of the main reasons for such a stark difference is lower inflation over the period FY2014-19. Inflation over the past 5 years has averaged 3.6% compared with 8.4% in the prior 5 year period. Though real GDP growth over both these periods have been nearly the same, nominal GDP growth over the past 5 years has been 10.8% pa compared with 15.1% in the prior 5 years, primarily due to higher inflation during FY2009-14. Another contributor to the higher profit and revenue growth in FY2009-14 is the low base of FY2009 which was near the bottom of the global financial crisis. As investors, it is important to view growth rates adjusted for inflation.

Many of the larger companies in India are commodity centric and these companies have been among the worst hit in the global economic slowdown that we are experiencing, where commodity prices have been soft. The current margins for many of these companies are less than historical levels. Moreover, PSU Banks, telecom and some industrial companies have also seen poor performance over the last 5 years. Apart from the sectors mentioned above, the overall growth rates have been reasonably good.

With the Nifty near an all-time high, its valuations are on the higher side. On the other hand, the Nifty Mid-cap 100 index is trading nearly 18% lower than its peak levels. The broader market correction is throwing up some opportunities for investors, but this is a market where one needs to be cautious as the average company valuations are not favorable. Investment opportunities are few and selective.

Consumption has a large role to play in India’s GDP and the good news is that the Indian consumption story is strong. First, we have a young population, wanting to earn more and spend more. Second, the Indian consumer is under leveraged when compared to its global peers. Third, across the board we see under-penetration in most product categories compared with other countries which are ahead of India, in terms of per-capita GDP – offering huge and proven growth opportunities for companies over the long term. The role of the government, in many cases, is to remove the bottlenecks in realizing these growth opportunities.

The economy is experiencing some headwinds due to the current NBFC crisis and one expects the new government and the RBI to work towards resolving the issues. Growth pangs are part and parcel of any high growth economy and the good news is that institutionalized systems are evolving which can fix such issues. We are comfortable with the long term prospects for the economy but are keeping an eye on the valuations of companies.