Expert view: Earnings can double over the next 4-5 years; small-cap earnings expected to grow faster, says Equirus MD

Expert view: Sahil Shah, Managing Director (MD) and Chief Investment Officer (CIO), Equirus, believes one or two quarters of earnings misses or external events could disrupt the Indian stock market in the short term. However, corporate earnings in the broader market can double over the next four to five years, with small-cap earnings expected to grow even faster. In an interview with Mint, Shah shared his views on the impact of the US election on the Indian stock market and emerging investment themes.

Edited excerpts:

What is your outlook for the Indian stock market for the new Samvat?

A consistent narrative around expensive valuations has emerged between the last Samvat and the current one.

However, during this period, Nifty 100 has surged by 32 per cent, with midcaps and small-caps rising over 40 per cent, microcaps climbing 50 per cent, and the SME IPO index skyrocketing by 138 per cent.

Despite this impressive trajectory, we have witnessed minor corrections of 5-10 per cent in the small-cap index, indicative of the market’s inherent volatility.

Recently, increased fluctuations have been observed, largely due to shifts in allocation and foreign institutional investor (FII) selling.

Specific sectors like defence have also experienced corrections after substantial valuation run-ups.

Looking ahead, quarterly earnings and market sentiment will play pivotal roles in determining market movements, which remain difficult to predict.

The unexpected Chinese stimulus, for example, has led to shifts in global allocation, contributing to recent volatility in Indian markets. We believe this turbulence is temporary.

India’s fundamentals remain robust compared to many larger economies.

While one or two quarters of earnings miss or external events could disrupt the market in the short term, we are confident that corporate earnings in the broader market can double over the next four to five years, with small-cap earnings expected to grow even faster.

How do you see the current market valuation? As Q2 numbers are expected to be soft, is it time to be cautious?

Based on trailing earnings, small midcaps are trading at 32 times P/E (price-to-earnings ratio). Given that this is average, opportunities are available at reasonable valuations, which have been reduced over time as markets and valuations have increased.

While financial services carry significant weight in large-cap indices at or below historical valuations, capital goods and consumer discretionary have large weightage in small-cap indices, where companies trade at very high multiples on a trailing basis.

When we look at the growth rates of small-cap capital goods companies, they have grown at 30 percent+ in Q1FY25, which is far ahead of the aggregate growth of small-cap companies.

This explains why large caps trade lower multiples than small caps under the current scenario. The fiscal year 2024 witnessed remarkable earnings growth among NSE 500 companies, accompanied by moderate revenue growth.

However, in Q1FY25, the gap between earnings growth and revenue growth has narrowed considerably.

This trend raises important questions as we assess the sustainability of earnings in light of broader economic indicators.

High-frequency data points, such as GST collections, automobile sales, and cement demand, suggest a deceleration in growth, but we anticipate gaining clearer insights as Q2FY25 figures are released.

While specific sectors may still represent reasonable valuations, the overall market increasingly reflects an optimistic outlook, particularly in pockets where valuations have escalated.

This optimism carries the risk that any earnings misses could lead to market volatility.

Can the Indian stock market witness a deep correction?

India’s corporate balance sheets are currently in their strongest position in years, paralleling the robust health of the banking sector.

Furthermore, our external balances are well-managed, supported by solid reserves, and the fiscal deficit remains firmly under control.

Given this favourable backdrop, it seems unlikely that we will experience a significant market correction, barring unforeseen geopolitical events or a hard landing in the US economy.

However, we should remain aware that smaller corrections cannot be entirely dismissed.

Over the past twenty years, small-cap and mid-cap indices have experienced intra-year corrections of at least 10 per cent from their calendar-year highs, even during the most robust bull markets.

It is important to note that these corrections often occur from peaks that are only clear in hindsight, emphasising the inherent volatility of these segments.

On a positive note, it is worth highlighting that three out of four years during this two-decade span have delivered positive returns, with an average annual return exceeding 20 per cent.

This resilience illustrates the solid long-term growth potential in Indian equities, particularly within the small-cap and mid-cap segments.

As we navigate the current market landscape, we must remain vigilant and prepared for short-term fluctuations while focusing on the underlying strength of corporate fundamentals.

How could the US election impact the Indian stock market?

Kamala Harris’s approach is to increase taxes and focus on systemic change and global cooperation, while Trump’s ideology centres on tax cuts, nationalism, and a more isolationist foreign policy.

These differences reflect broader political and social divides in the US.

During his tenure, Donald Trump’s more isolationist policy did not impact India’s export-oriented sectors, such as IT services, chemicals, and healthcare.

RBI changed its policy stance in October, but the recent CPI inflation data showed that inflation remains a pain point. What are your expectations about the interest rate trajectory?

RBI maintained the policy rate at 6.5 per cent as expected but changed its stance to “neutral” from “withdrawal of accommodation.” The key driver for this change is the growth-inflation balance, which creates a congenial condition.

In summary, with the US rate cut, fiscal consolidation and India’s external position with robust reserves giving some room for accommodation, RBI probably feels it is too early to let the guard down.

A neutral watch rather than a hawkish watch provides more flexibility to act when the time is right.

In contrast, while the Federal Reserve appears to be taking actions based on forecasts, the RBI’s strategy seems firmly rooted in real-time data and economic realities.

This data-driven approach positions the RBI to navigate potential challenges effectively, ensuring it remains responsive to domestic and global economic shifts.

What sectors should one look at if one has to buy for the long term?

We believe emerging themes are too expensive, while traditional themes/sectors are better placed in terms of valuations.

In the new Samvat, it’s time to look at the “traditional” sectors. For example, we like IT services, lending financials, and chemical stocks at the current juncture because they have underperformed in the past two years, making valuations more palatable.

This has happened as they have gone through a rough patch. The reasons for different earnings growth and the visibility of such growth over the medium term were challenging.

We are at the fag end of the challenging phase or, in some cases, have been out of that.

Hence, it appears to be at a perfect juncture where growth is not fully priced, but positive earnings surprises are possible.

Do you observe some emerging investment themes? What is your view on new-age tech firms?

New-age tech has delivered far superior growth compared to its traditional counterparts, whether Policy Bazaar versus some insurance companies or Zomato versus QSR companies.

More importantly, most of the new-age tech firms listed when reporting losses, but in the last few quarters, they have either reduced losses significantly or started reporting profits.

Given that the growth outperformance will continue given that JAM (Jan Dhan, Aadhar and Mobile) trinity allows for more adoption and penetration, and the path to profitability is becoming more visible, valuations are pricing in significant profitability increase over the next two to three years.

How can investors protect their wealth amid market volatility?

The risk of volatility and returns are two sides of the same coin. Hence, short-term volatility cannot be avoided to make returns substantially above inflation.

However, through smart allocation decisions, volatility can be somewhat reduced.

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Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.