Hit by coronavirus, earnings estimates are being downgraded; here’s how this could be good

After overestimating Nifty’s one-year forward earnings per share by 20% on average for the over half a decade, the coronavirus pandemic has presented equity market analysts with an opportunity to set the record straight and get their estimates back on track. The coronavirus pandemic has resulted in a downgrade of close to 30% for Nifty 50 earning for this fiscal which implies a 10% downgrade on net basis assuming that the 20% over-estimation error has persisted, said a report by brokerage and research firm ICICI Securities. Analysts at ICICI Securities said that such a downgrade could result in reduction in estimation error in Nifty 50 EPS going ahead.

“Consensus one year forward earnings forecast for the NIFTY50 EPS has erred consistently on the side of optimism for the period CY14-19 with an average over-estimation error of ~20%,” the report said. Since prior to the dawn of the coronavirus pandemic that marred the supply chains and disrupted businesses, analysts have been scaling back on their earnings expectations for financial year 2021 and financial year 2022 after painting a rosy picture since 2014. ICICI Securities says the downgrade ranges from 30% to 15%. This downgrade could be a blessing in disguise for the overestimates to be recalibrated.

According to the report, the downgrades resulting from the Global Financial Crisis of 2008 saw forward earnings being downgraded by 21%, thereby decreasing the estimation error to zero by 2010. “As seen post-Global Financial Crisis, such sharp downgrades have led to reduction in estimation error in Nifty 50 EPS going ahead, especially if the economic revival happens in the next year, and is the base case in the current scenario,” the report said. Sector-wise, metals have seen the worst of earnings downgrades for this fiscal while FMCG has seen the least downgrade.

The overestimation of forward earnings has been driven by a number of factors. Political factors fueled the overestimation with hopes of private capital expenditure revival, the reforms initiated by the government and the Reserve Bank of India added to it. ICICI Securities also noted that the sharp rally in stock markets from March lows has impacted the risk-reward ratio. “Forward P/E and Trailing P/E are much higher than long term averages. However, Market cap to GDP at 70% is below LTA,” the report said while warning that returns over the next one year could be in single digits.