Sensex 1,75,000 by 2025: Are You Ready?

Jan 4, 2021

Rahul Shah, Editor, Profit Hunter

That corporate earnings have developed an allergy to strong growth could well be an understatement.

If a leading brokerage is to be believed - there's no reason to not believe it - aggregate earnings of Nifty 50 companies or Nifty EPS in short, has grown at a snail's pace of 3% between FY14 and FY20.

Earnings growth for the previous six year period i.e. FY08 and FY14 hasn't set the charts on fire either. Although better than 3% CAGR, the growth was still a sub-par 6.3% during this period.

Now, what this dirty dozen has done is that it has consigned the earnings CAGR during this 12-year period (FY08-FY20) to a little over 4%.

Even if you consider the last 10 year period, the earnings CAGR stand at a poor 6.5%.

This makes me wonder what has changed between this decade and the previous one for the earnings growth to nosedive to such an extent.

Do note that between FY00 and FY10, corporate earnings were going great guns, growing by almost 13% per annum.

To see this growth fall by almost 50% in the next decade is indeed perplexing.

Luckily for us, there's a precedent in place that will help put these numbers into perspective.

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You see, there was a similar 6-year period between FY97 and FY03 where earnings growth had slowed down to a little over 3%. This is exactly similar to what has happened in the last six years.

And how did the earnings perform over the next five years?

Well, they came roaring back and recorded one of the strongest growth rates ever. Yes, that's correct.

Earnings between FY03 and FY08 grew at a staggering pace of 25% per annum.

A lot of experts put down this contrasting five-year periods to reforms undertaken by the then government.

And since bold reforms usually result in short term pain in exchange for long term gain, the growth fell in the first five year period and more than made up the lost ground in the next five.

Worth pointing out that the second five year period also led to a great bull market on the stock exchange.

The benchmark index went up almost 7x during this period and recorded one of its strongest performances ever.

Well, you must have gotten the drift by now.

Since FY14-20 looks eerily similar to FY97-03 where earnings growth has averaged a paltry 3% and where some big, bold reforms have been launched, will history repeat itself?

Will the earnings growth once again make up for lost ground and launch itself into a much higher orbit?

To be honest, no one knows the answer to this question.

However, what is also true is that we don't have an economic system where earnings growth will permanently clock 4%-5% growth. Our system is definitely capable of doing much better than that and it is also the need of the hour.

We simply cannot put millions of people to work and provide livelihood to billions by having a corporate structure that grows at just 4%-5%.

What's equally true is that we have to again go back to the long term CAGR of 13%-14% and therefore, if we've had a period of sub-par growth, we need a period of above-par growth as well. Something like a 20%-25% CAGR in earnings over a 5-6 year period to be precise.

Thus, taking all of these factors into account, I would say there's more than a 50:50 chance that a short burst of very strong earnings growth is upon us.

It would be quite difficult to pin down its exact starting point. However, I won't be surprised if the earnings growth take off in the next year or two.

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Now, the most important thing.

The last time this happened, the BSE Sensex went up almost 7x in under 5 years. Will it do an encore this time?

Hmm... there's one big difference this time: valuations.

When Sensex went up almost 7x the last time around, it entered the 5-year period at a price to earnings multiple of 13x-14x. This is quite attractive in my view and significantly below its long term average of 18x-19x.

Thus, it is the expansion in PE multiple plus earnings growth that combined to give a 7x return on the Sensex.

The PE multiple as of writing this stands at more than 30x. This is significantly higher than the historical average.

Therefore, unless this comes down to 13x-14x or lower, I don't think Sensex can achieve a similar 7x growth over the next 5-6 years.

Anyways, I do see a level of 1,75,000-1,80,000 on the Sensex by FY25-FY26 well within the realms of possibility.

Now, whether the Sensex jumps to this level by testing a low of 25,000-30,000 or goes up in a straight line, is what remains to be seen. Going by its history, I will bet on the former scenario.

Therefore, I recommend you to take a 50% exposure to stocks right now and invest the rest when the market has undergone a significant correction.

If you are not willing to do that and be 100% invested, fair enough. Your returns may still look decent.

Either ways, exciting times lie ahead for the Indian stock market.

What do you think?

Let me know your thoughts by writing to us here.

Good Investing,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

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