Portfolio forward returns will be driven by sectoral allocation and stock selection

Published: May 2, 2018 12:13:42 AM

Insights from comparing the Nifty 50 with the CNX 500 excluding the Nifty 50 show that while the Nifty 50 has grown profits at 9.7% CAGR over the past three years, the CNX 500 excluding the Nifty 50 has grown earnings at 18.8%.

Portfolio, Nifty, Nifty 50, Sensex, CNX 500, PAT, CAGR, foreign investorsAnother way of stating it is that the trailing PEG on the Nifty 50 is an expensive 2.8 times versus a more reasonable 1.8 times for the excluding Nifty.

Insights from comparing the Nifty 50 with the CNX 500 excluding the Nifty 50 show that while the Nifty 50 has grown profits at 9.7% CAGR over the past three years, the CNX 500 excluding the Nifty 50 has grown earnings at 18.8%. That’s twice the PAT growth rate of the Nifty 50. Secondly, the expected profits growth for the Nifty 50 over the next three years is 19.6%, while that for the CNX 500 excluding Nifty 50 is an even more impressive 32.8%. Granted, forward estimates are often unreliable, but the relative spread is meaningful, and remains above 12 percentage points.

Despite these meaningful differences in growth rates, it is notable that the relative valuation for the Nifty 50 in FY19 is only 5.5 percentage points lower at 21.4 times versus the CNX 500 excluding Nifty 50 at 26.9 times. The spread is similarly low for FY18 as well, at 6.9 percentage points and valuations are essentially even at FY20. For a slight premium in valuation, investors receive nearly twice the growth rate in the CNX 500 excluding Nifty universe. Another way of stating it is that the trailing PEG on the Nifty 50 is an expensive 2.8 times versus a more reasonable 1.8 times for the excluding Nifty.

Q4FY18 earnings: So far so good

The early data on Q4FY18 earnings, as is usually the case, has been encouraging, particularly in private financials and mid cap IT. Sales and profits are up double digits for most companies reporting to date. A truer picture will emerge on earnings as we head in to the second and third leg of earnings season. In the prior quarter, a healthy 269 companies grew top line by at least 10% year-on-year (y-o-y), and an equally healthy 256 companies grew earnings by 10% y-o-y.

Growth this quarter is likely to come through as well, and hopefully will move the needle lower on index valuation. However, divergences in the PSU space are likely to remain an overhang. The Nifty 50 P/E is at 26.5 times.

Outlook: No change on fixed income

The announcement by Reserve Bank of India to allow foreign investors to invest in shorter term bonds should allow rates to fall marginally, and could possibly bring additional flows into the market, bringing much needed relief. There is no change to our fixed income outlook.

Rising crude prices, weakening FDI flows, weakening rupee, a widening trade deficit and stretched government finances have been negative contributors. However, India sports strong growth, low inflation, strong forex reserves, a healthy consumer and strong fiscal discipline. Talk of a hike in rates appears premature. The key call remains crude, and the rapidity with which shale bottlenecks are addressed will determine future crude oil price movements.

Asset allocation

In our asset allocation models, we are slightly underweight equities, slightly underweight gold and correspondingly overweight fixed income. We will look to up our weight in equities should valuations revert to reasonable levels. On a further extension of over-valuation, we will look to further reduce our allocation. Our analysis reinforces our view that the CNX 500-excluding Nifty remains an attractive choice as long as the fundamentals of the economy remain healthy.

By Sunil Sharma

The writer is chief investment officer & ED, Sanctum Wealth Management. Edited excerpts from Investment Strategy by Sanctum Wealth Management

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