In the long run, stock prices are a slave to earnings, they say. With corporate earnings recovering strongly from the Covid blow in the last two years, earnings growth for the Nifty-50 index has been impressive, at 22 per cent and 36 per cent year-on-year in CY21 and CY22 respectively (Bloomberg consensus estimates).

Earnings growth for CY23 is expected at 18 per cent. However, closing at around 17,600 on April 6, the Nifty-50 index has not gone anywhere since the October 2021 peak, so far returning a negative 4 per cent since then. What’s in store?

Earnings correction likely

In CY22, Nifty-50 index returns on a 3-year basis underperformed earnings growth by 4 per cent. In CY23 so far, the underperformance increases substantially to 17 per cent. The gap between index and earnings should play out in the remainder of CY23 in one of two ways – either earnings correcting, or index returns catching up. But the odds seem more in favour of earnings coming down.

High inflation and interest rates climbing up in the last two years impacted margins on one side (through commodity cost inflation) and demand/capacity building on the other (through higher cost of borrowing). But earnings growth surpassed index returns despite these factors, aided by the low base from Covid times. Investors seem to now be more concerned on the future trajectory of earnings growth, showing low confidence on the double -digit growth expectations for CY23.

The recent banking crisis in the US, worries over both global and domestic slowdown and inflation are the key reasons behind this scepticism.

Also read: Corporates performed resiliently in H1 FY’23: Ind-Ra

May play catch up soon

That said, with 4 and 17 per cent 3-year CAGR underperformance of Nifty-50 against earnings in the last two years, despite possible correction in earnings estimates going forward, the index should be poised to close the gap with earnings growth in one to two years’ time.

Easing up of the rate hike cycle by central banks could be a key determinant. Among sectoral indices, Nifty Bank seems poised to close in on the gap too. The index has underperformed its earnings growth on a 3-year basis by 7/31/20 per cent in the last three years and the underperformance continues in CY23 at 21 per cent, implying a lot of catching up to do.

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