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Monday, Apr 26, 2004

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Higher GDP doesn't mean more profits — Good only for levies and employees

Suresh Krishnamurthy

STOCK market axioms have it that higher GDP (gross domestic product) growth leads to even higher growth in profits of listed companies. Or do they?

An analysis of the financial performance of 125 major companies over the period between 1995 and 2003 suggests that it is not the case. Profit growth of these companies, if anything, has lagged GDP growth.

These have implications for stock price valuations that now factor in earnings growth that is higher than GDP growth. GDP is a measure of value of output in a year.

In the period between 1995 and 2003, industry's nominal GDP has grown at an annual average of 10.6 per cent. Profit growth has, however, lagged behind at 9.1 per cent.

In contrast, duties and taxes have grown at a compounded rate of 10.7 per cent. Similarly, employee costs have grown at 11.7 per cent.

This suggests that growth in output of the industry (GDP growth) may be good for growth in government levies (income-tax and excise duties) and employees and not necessarily for profit growth of listed Indian companies.

There have been exceptions.

In 2001 and 2003, profit growth was indeed substantially higher than that of GDP growth. This, however, was mainly due to compression of interest cost, and to lower government levies and reduced depreciation charges. Going forward, if interest costs do not decline further and depreciation charges mount because of higher investments, profit growth will remain muted even if GDP grows at a higher rate.

Besides, earnings growth of listed Indian companies has been more volatile than that of GDP industry growth.

In three of the past eight years, profits of listed Indian companies have declined.

In contrast, GDP of the industry has never declined, although growth rates have dipped.

These numbers indicate that listed Indian companies have to break from the past if they have to satisfy stock market aspirations.

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