Ahead of key financial results next week, the benchmark BSE Sensex retreated over 400 points intraday on Friday. IT majors Tata Consultancy Services, HCL Technologies, Wipro and brokerages including 5Paisa, Anand Rathi and Angel One will announce their June quarter results next week. Will the results season dent the current momentum in the equity market? In an interaction with Business Today, Manish Goel, Founder and Managing Director of Research & Ranking, shared his insights on the Q1 earnings season, sectors that may surprise D-Street and market valuations. Edited excerpts:

BT: What are your expectations for the Q1 earnings season?

MG: Nifty50 companies are likely to report healthy earnings growth in Q1FY24. The overall domestic demand environment looks promising, while sectors that rely on export may continue to face challenges. The positive outlook in the domestic markets is supported by several factors, including robust industrial activity, ongoing government investments in infrastructure and the expectation of 8 per cent year-on-year growth in the GDP during the first quarter.

Furthermore, the companies’ earnings are expected to benefit from improved profit margins across most sectors. Prices of base metals, crude oil, and coal have eased, which bodes well for expanding profitability. Additionally, despite a delayed start, the monsoon has progressed rapidly and current forecasts predict normal rainfall in most regions.

At a sectoral level, strong performances are expected in sectors such as banks, oil refining, healthcare, building materials, select industrials and FMCG, as well as for two-wheeler and passenger vehicle manufacturers. But, sectors such as information technology, metals & mining, agrochemicals and retail may disappoint markets.

During this result season, we will closely watch management commentaries regarding possible pick up in rural demand and for clearer indications on an upturn in the private capex cycle. Overall, we believe it to be a good quarter for corporate India.

BT: What are you views on the prospects of IT stocks?

MG: IT companies are expected to face a muted first quarter weighed by a weak macro environment. We anticipate that delayed discretionary spending and project ramp down which was seen in March might see its full impact during Q1, with a specific pullback in projects from the financial services and telecom sectors. Although the deals pipeline remains stable, the conversion rate is expected to be slow resulting in short-term earnings pressure.

Furthermore, slower growth and rising wages may exert pressure on profit margins during the first quarter of FY24. However, some relief might be due to relatively lower employee attrition rates and improved resource utilisation.

Since sector valuations have also moderated over the past year due to a subdued demand outlook, we recommend adopting a selective bottom-up approach to the sector, from a long-term perspective. We believe Tier 2 IT companies with agile business models and robust growth guidance on the back of a strong order book and deal pipeline are possibly better placed than Tier 1 IT companies.

BT: What is your outlook on the valuation of the Indian equity markets? Do you think the bull run will continue on Dalal Street in the second half?

MG: Nifty is scaling new highs, which might give the impression that valuations are stretched. However, this is not the case. Projections suggest that the earnings per share (EPS) for Nifty universe stocks will range between 16-17 per cent from FY23 to FY25. As a result, the market is trading at a forward price-to-earnings (PE) ratio of 17.5-18.0 times, which is lower than the long-term average.

The market’s strength is supported by several favourable macroeconomic factors. These include increased credit offtake, stable inflation, declining energy prices, robust industrial activity, reduced fears of a recession, a globally peaking rate hike cycle and the deleveraging of Indian corporate balance sheets. Additionally, Indian markets are being rerated based on strong GDP prospects compared to leading economies worldwide. The return of liquidity in the markets is also providing a supportive tailwind.

Considering these positive fundamental and market factors, currently, there is no immediate cause for concern regarding market levels. On the contrary, any market correction should be viewed as an excellent opportunity by long-term investors to accumulate high-quality stocks at favourable prices.

BT: What is your asset allocation strategy?

Goel: Our investment approach follows a long-term, fundamental-driven strategy. Considering the impressive returns delivered by our market over the past two decades, we recommend investing in a thoughtfully curated portfolio of high-quality stocks if the goal is to create wealth in the long term.

Given the positive outlook for our economy and the potential for long-term expansion in India, we firmly believe that a well-diversified stock portfolio, comprising financially robust and low-risk companies, has the potential to generate returns of approximately 18-20 per cent over the next 5 to 7 years.

Market participants should not blindly follow any strategy. Before investing it is essential to assess your risk tolerance and establish clear investment objectives before determining the asset allocation that is most suitable for you. Normally, a balanced mix of fixed income, equity, and real assets is recommended to achieve a well-rounded investment strategy.

BT: Which sectors do you believe have the potential to outperform in the next 12-24 months?

MG: We believe the automobile industry, specifically the electric vehicle segment, is poised for growth due to favourable government policies supporting its development.

Additionally, driven by a strong demand environment, we hold a positive view of consumer discretionary sectors.

Other than these sectors, we see potential in the select new-age businesses. Particularly, we find promising opportunities in businesses focused on the Quick-Service Restaurant (QSR) and fashion/personal care segments.

Furthermore, the traditional financial services sector appears attractive, benefiting from robust credit growth in the economy that exceeds 15 per cent levels.

Given the government's emphasis on promoting domestic production through initiatives like the Production-Linked Incentive Scheme (PLI) and Atmanirbhar Bharat, we are also positive about the manufacturing sector.

Lastly, due to the ongoing infrastructure thrust from the government and robust real estate demand, we hold a positive view of the building materials space. We recommend investing in this space through sectors like pipes, consumables, and electricals.

BT: How do NBFCs compare with banking stocks in terms of prospects?

MG: We believe that the financial services sector overall is in a sweet spot. There is healthy credit offtake at a systemic level and sustaining at over 15 per cent. Asset quality, as highlighted in the RBI’s Financial Stability Report, is also exceptional. The early warning indicators (SMA 1 and 2) are also meaningfully lower compared to pre-Covid levels indicating that asset quality is likely to remain good. Additionally, companies have made sufficient provisions for non-performing assets and their balance sheets are well capitalised. Moreover, valuations are currently below long-term averages, presenting attractive investment opportunities with a sufficient margin-of-safety.

Specifically in the banking space, we believe that the opportunity is relatively straightforward. One can expect a decent return in the medium to long term by focusing just on the top players in the industry. However, in the NBFC space, there may be potential for some momentum plays, as we anticipate earnings surprises due to a possible reversal in profitability as captured in their reported net interest margins. It is therefore advisable to invest in diversified players with higher earning visibility and companies that are well-positioned to benefit from the decline in cost of funds (CoF) as interest rates start to decline.

BT: What is your view on mid- and small-caps after their recent outperformance in 2023?

MG: Historically, the small-cap and mid-cap space tends to underperform during periods of uncertainty, as we witnessed during the Covid period. However, with inflation stabilising, positive macro indicators, and an apparent end to the rate hike cycle, we are now observing a catch-up in the small and mid-cap space compared to the front-line stocks. This presents a favourable investment opportunity in this segment. Nevertheless, it is crucial to exercise caution and employ a bottom-up approach when selecting stocks within this space.

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