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The past five years have been agonising for the Indian economy and this has been reflected in the corporate performance.
Returns on equity, the definitive barometer of shareholder returns, slowed down considerably to a mediocre single digit of 5 per cent for the Sensex companies in FY13 as against 22 per cent in 2008.
Lower GDP growth inevitably translates into poor corporate performance. But such low returns on shareholder equity have never been seen before in the Indian markets. Even when the Indian economy grew at a sluggish 5 per cent in FY03, the RoE for Sensex companies was still a sturdy 16 per cent.
But judging by several factors, this situation looks more an aberration than the norm. The largest mandate for the ruling party since 1984 has now heightened hopes of vast structural changes in the Indian economy.
Reforms usually boost capital formation and investment spending by Indian companies. Already, green shoots have begun to emerge. These will consolidate and trickle down to the rest of the economy.
When the economy begins to realise its potential, growth conditions for Indian companies improve exponentially. Operating efficiencies of Indian companies take a turn for the better as the investment cycle turns around and companies begin to see better cash flows, which reflect in their return on equity. And this has, in the past, happened often.
Consider this. As economic growth in India rose from below 4 per cent in FY03 to over 9 per cent in FY08, the Sensex’s RoE shot up from around 18 per cent to well over 22 per cent. The Sensex’s earnings per share (EPS) growth, too, registered exceptionally high double-digit movements, clocking an average EPS rise of around 22 per cent between FY03 and FY08.
The Indian growth bandwagon reversed direction between FY09 and FY13 as the financial crisis and global slowdown, coupled with a deceleration in domestic capital investment and lack of reforms, struck a huge blow to the economy. Most Indian industries recorded a crippling decline. The Sensex clocked an average EPS growth of a mere 7.4 per cent in this period.
However, this may not last much longer. The economy now looks poised to gain enormously as the operating environment improves. Under-utilised capacities, while incurring huge fixed costs, may no longer dent performance. Both the scale and the size of the potential growth rate of Indian companies present hugely discounted opportunities for investors seeking to re-invest in companies that promise growth. The structural changes taking place in the Indian economy will lead to several companies seeing a return to higher levels of return on equity.
Decisive moves After 1984, only now has a single party won such a thumping majority. This is a structural change for the Indian economy as, over the past three decades, we have only seen coalition governments. The new government is now expected to take decisive measures to clear supply-side bottlenecks. This will lead to lower inflation and, therefore, pave the way for lower interest rates. The government is expected to take steps to clear stalled projects and reform the power and infrastructure segments.
The de-bottlenecking of several projects which involve lower capital outlay but can improve capacity utilisation could see growth rates spurt. And a fall in interest rates could lead to a revival in the investment cycle, leading to substantial improvement in the earnings of the industrial sector.
Equity investing tenets have clearly shown in the past that investors should go for equity - particularly seek growing companies - when GDP growth is low, IIP is low, and the fiscal deficit is improving.
Valuations are low when earnings are bottoming out. It is also best to invest when investors are under-allocated towards equity.
This calls for serious re-visiting of expectations from the equity market and buying into good growth companies for the long term. After nearly half-a-decade of lacklustre stock market returns, and benign returns on shareholder equity, investors are now more likely to do well.
One should use this golden opportunity to re-invest in growth.
(The writer is MD & CEO, ICICI Prudential AMC)
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