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Did the Tax Bonanza Really Deserve a 2,000-point Gain on the Sensex?

Sep 20, 2019

Rahul Shah, Editor, Profit Hunter

Just when it seemed the bears had the markets in their vice like grip, Nirmala Sitharaman has come in and administered what I believe is the biggest booster shot in recent memory.

Her announcement of bringing down the corporate tax rates from the current 30% to 22% and 15% have sent the markets into a buying frenzy.

As I write this, the Sensex is up a whopping 2,000 points. It looks all set to break the long-standing May 2009 record of highest single day gain of 2,111 points.

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I appreciate the move and certainly think of it as long-term positive for the economy. However, I have also tried to dig deeper and analyze whether the markets are justified in their optimism. For all you know, they may be overdoing the euphoria.

Here's what I found out.

The biggest complaint against the rise of the Sensex in the past few years has been the poor contribution from earnings growth. What it means is that the Sensex has been boosted more by the improvement in sentiments. There has been no real improvement on the ground.

I guess the complaint is justified.

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While the Sensex has gone up by 80% since the start of 2014, earnings have only grown at a CAGR of 4%-5% as opposed to the 14%-15% growth we are used to.

Now, what the Finance Minister has done is give a huge one-time impetus to this earnings growth.

A shift in corporate tax rate from 35% to 25% in my view will directly lift EPS growth by 15%-20% in the forthcoming fiscal.

Therefore, everything else remaining constant, the tax bonanza will bring about a 20%-25% one-time EPS adjustment for India Inc and by extension for all the Sensex companies as well.

I say one-time because next year onwards, growth rates will be calculated on this new higher earnings base and are likely to revert to their long-term average of 14%-15%. They can even stay at current 4%-5% rate for few quarters more.

Therefore, from a short-term perspective, all that the tax bonanza has done is bring down forward PE multiple from an expensive 25x to a more reasonable 20x. However, I wouldn't still call the markets a screaming buy given its long-term average of 18x.

Now, the long-term perspective. Will the tax move give a boost to GDP growth in the long run? It very well could. As the Finance Minister mentioned, the tax cut has in one stroke brought corporate taxes to amongst the most competitive in this part of the world. This may very well entice companies to set up shop here.

However, this is only a small part of the problem solved in my view. We will have to do a lot more to move to structurally higher GDP growth rates of 8%-9%. And it is here that the Government's mettle is going to be tested.

Besides, it hasn't helped its case by setting expectations even higher. It has rolled out ambitious targets like the US$ 5 trillion economy, share of manufacturing in GDP to 25% and of course doubling farmer income amongst others.

Don't get me wrong. I think we can still grow at 5%-6% without any incremental reforms. And I still believe the long-term stock market news will be good. However, can we break away and move into a much higher orbit? Sadly, I don't see a lot of evidence of that yet.

Therefore, I would recommend investors to keep their optimism in check. Just as they underreacted to the recent bad news, they shouldn't over react to this announcement. Some of the stocks were certainly beaten down on account of a lot of pessimism. Their rise was only a matter of time. However, investors would do well to not become too greedy and ignore valuations completely.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

PS: Dear reader, yesterday evening I published my second video class on doubling your income! Full details here...

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1 Responses to "Did the Tax Bonanza Really Deserve a 2,000-point Gain on the Sensex?"

CHIRAYUSH VAKIL

Sep 20, 2019

Hi,Sensex growth of 80pc since start of 2014 and CAGR of 4_5pc.during this period.Can you please share the relevant data/figuures and oblige.Thanks and regards.

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Equitymaster requests your view! Post a comment on "Did the Tax Bonanza Really Deserve a 2,000-point Gain on the Sensex?". Click here!