‘Market Correction Allows Investors To Think About Valuation & Ideas’: Motilal Oswal’s Gautam Duggad

Summary

In this insightful discussion, Gotham, the Head of Research at Motilal Oswal, explores the current market outlook, emphasizing the challenges and opportunities for investors. Despite weak earnings growth in FY25, driven mainly by commodity sector fluctuations, there’s hope for steady growth in the second half of the year. Market corrections are seen as healthy, with large-cap stocks now offering better value, particularly in Nifty50. Geopolitical tensions are raising equity risk premiums, but strong domestic flows are helping stabilize the market. The focus shifts to selecting stocks with strong earnings potential and reasonable valuations amidst broader market volatility.

Takeaways

• 😀 Earnings growth for FY25 has started on a muted note, with only 4% growth for Nifty and flat earnings for the coverage universe.
• 😀 Excluding commodity impacts, the coverage universe shows an 11-12% earnings growth, highlighting the disproportionate effect of commodity prices.
• 😀 October marked a significant market correction of over 5%, the first since March 2020, indicating a necessary adjustment in market valuations.
• 😀 The current market environment allows investors to reevaluate stock valuations and earnings performance, leading to a more discerning investment approach.
• 😀 Despite the overall moderation, large-cap valuations have improved, with the Nifty50 trading below 20 times FY26 earnings, suggesting potential opportunities.
• 😀 Geopolitical tensions, including conflicts in Ukraine and the Middle East, increase the equity risk premium and impact market sentiment.
• 😀 Domestic retail flows have absorbed significant foreign selling, reflecting strong local investor interest despite external uncertainties.
• 😀 There is a narrowing of sectors contributing to earnings growth, requiring investors to be more selective in their stock picks.
• 😀 Finding companies with strong earnings potential is becoming more challenging, necessitating a focus on firms with solid balance sheets and reasonable valuations.
• 😀 The current market landscape presents a unique opportunity to build a solid foundation for consistent returns over the next two to three years.

Q & A

What is the current state of earnings growth for the Nifty and the coverage universe in FY25?

Earnings growth for the Nifty and the broader coverage universe has slowed down in FY25, with a flat growth for the coverage universe and a modest 4% growth for Nifty. This slowdown is largely attributed to underperformance in the commodity sector. When excluding commodities, the growth rate for both the Nifty and the coverage universe rises to around 11-12%.

How does the performance of the commodity sector impact overall market growth?

The commodity sector has a disproportionate drag on earnings, and its underperformance significantly impacts overall growth. When commodities are excluded from the analysis, the growth figures for both the Nifty and the broader universe are significantly better, indicating the strong performance of non-commodity sectors.

What does the expert think about the market correction that occurred in October?

The expert views the market correction in October (5% correction) as healthy. It provides an opportunity for investors to reassess the market, look for bottom-up stock ideas, and identify sectors with strong earnings growth and reasonable valuations.

Has the market been too forgiving in the past, and how has that changed recently?

Yes, the market has been quite forgiving in the past, especially when companies missed earnings estimates. However, in the October quarter, the market became more discerning. Stocks were rewarded for good earnings, while those with poor earnings faced significant punishment, which the expert believes is the right approach.

What is the current valuation situation in the large-cap versus mid-cap and small-cap segments?

Valuations for large-cap stocks, represented by Nifty50, have become more reasonable, with the index now trading at below 20x FY26 earnings, which presents a potential upside. On the other hand, mid-cap and small-cap indices remain expensive, with the mid-cap index trading at 30x earnings and the small-cap index at 23x earnings.

Why does the expert think the market may narrow down?

The expert believes the market will narrow down because the number of sectors showing strong earnings growth is decreasing, and high valuations are a problem in the broader market. This narrowing is a natural consequence of fewer sectors delivering consistent growth amid expensive valuations.

What is the expert's outlook if the market stays at current levels for the next few months?

If the market stays within the 24,000-25,000 range for the Nifty, it will create a solid foundation for consistent returns over the next two to three years. This assumes earnings expectations remain stable and there are no significant downgrades in numbers.

How have geopolitical events like the Russia-Ukraine war and the Israel-Palestine conflict impacted market sentiment?

Geopolitical events increase the equity risk premium, which makes the market more volatile. These events contribute to investor nervousness, leading to selling pressures. However, strong domestic retail flows have helped absorb the selling, providing stability in the market.

What is the expert's take on the role of domestic retail flows in the current market?

The expert highlights that domestic retail flows have been instrumental in absorbing the selling pressures from international investors. This strong inflow has helped stabilize the market, particularly in the broader market segments like mid-caps and small-caps.

What factors does the expert consider when selecting stocks in the current market?

The expert focuses on three main factors when selecting stocks: strong earnings visibility, a solid balance sheet (reflected in high return on equity), and reasonable valuations. This approach ensures that investors are not overpaying for growth and have a margin of safety in their investments.