Record corporate profits keep stock markets fired up

Mimicking the global indices, Indian index Nifty dragged 1% on Thursday. After an ascent of over 24% last year, Nifty continues to seesaw in the first week. Fed officials’ hawkish stance on interest rates, where they see faster rate hikes than market expectation, led to the sell-off in global stocks including India. Nifty is a composition of 50 top stocks based on market capitalisation.

The key question is: Will the market see a steep downfall in 2022 or today’s fall is just a small knee-jerk reaction to Fed's hawkish stance?

For starters, it is important to understand the two key factors that decide the direction of the equity market — price of money aka interest rate and the expectation of corporate earnings growth. With Federal Reserve and other central banks gunning for higher interest rates, foreign investors are making an exit. As per NSDL, data till January 05, FPIs sold ₹25,683 crore worth of equities in this fiscal.

Despite such heavy outflow, Nifty is in an upbeat mood. In the last two weeks, it staged a swift upmove of 1,100 points from the low of 16,410 seen on December 20. So, what is keeping buoyancy in equities?

Market optimists are counting on better corporate earnings for Nifty50 stocks. Nifty gained 15% in 2020 and 24% in 2021 as corporate profit of these 50 stocks zoomed from ₹3.17 lakh crore in FY20 to ₹4.2 lakh crore in FY21, as per Capitaline data. In the first half of the current financial year (till September 30), Nifty50 stocks have clocked ₹2.85 lakh crore of net profit. If the trend remains the same then Nifty50 stocks may create a new earnings record of over ₹5.5 lakh crore.

“A new record for corporate profits is what makes our market resilient despite outflow from foreign institutional investors,” said a fund manager on the condition of anonymity.

Market is expecting a stellar performance from financials and information technology sectors that hold 37.5% and 18% weightage, respectively. These two sectors combined are more than half of Nifty's weightage, and corporate earnings from both the sectors are meeting street expectations. Financials in Nifty index comprised six banking stocks, namely Axis Bank, HDFC Bank, ICICI Bank, Indusind Bank, Kotak Bank and SBI, and three non-banking finance companies (NBFCs), namely Bajaj Finserv, Bajaj Finance and HDFC Ltd.

As per Capitaline, profit of nine stocks under financials grew from ₹1.01 lakh crore to ₹1.2 lakh crore between FY20 and FY21. Despite Covid-19, financials have registered 18.52% growth in net profit between FY20 and FY21, which shows the strength of the sector.

According to Bloomberg Street consensus estimate, the financials are expected to have a 23-24% compounded annual growth rate (CAGR) between FY20 and FY24, with a share of about 31% in FY24 by Nifty companies’ earnings. For the record, in FY21, Nifty’s profit stood at ₹4.2 lakh crore and financials share in it was ₹1.2 lakh crore. By FY24, the street is expecting financial profit to more than double and touch ₹2.35 lakh crore.

But how will financials stage record double-digit earning growth if loan book growth is muted in range of 5-6%?

A fund manager with a foreign mutual fund reasoned that financials are making profit on the back of reduced provisioning. In 2018, banks were making a provision of 2-2.2% of total assets, which has now come down to 0.8%. Reduced provisioning is strengthening the bottomline and earnings per share of financials that are part of Nifty. More than half of financial sector profit will come from normalisation of provisioning. In the first half of current fiscal, companies representing financials in Nifty have clocked net profit of ₹71,581 crore. If the current trend in profit sustains, then it would easily surpass ₹1.5 lakh crore in FY22.