March 2024 / Q4 FY24
Where Is the Bubble? Going Granular Beyond Index Headlines
“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.”
Dear Investors,
FY24 has been a stupendous year for us — we clocked ~90% return for the year on our portfolio. At the beginning of the year when the markets were still in sombre mood and against most market predictions, we had called out in our March 2023 newsletter that FY24 should see significant value creation based on the business visibility we were seeing in our portfolio companies. We are glad that our understanding has played out to perfection to end the year at such a high.
Equitree has once again emerged amongst the top 10 BEST performing PMSs in India across all categories, with 89.63% returns beating the benchmark by 49.47%[1][2]. It is now the 4th year in a row that Equitree has been amongst the top 2% best-performing PMSs in India consistently across all strategies.
Our Performance
| Investment Period | 1 Month | 3 Months | 6 Months | 1 Year | 2 Year | 3 Year | 4 Year |
|---|---|---|---|---|---|---|---|
| Emerging Opportunities | -5.64 | -5.37 | 14.38 | 89.63 | 36.04 | 35.99 | 55.53 |
| BSE 500 TRI | 0.86 | 4.49 | 17.40 | 40.16 | 17.82 | 19.28 | 31.97 |
| Outperformance | -6.50 | -9.86 | -3.02 | 49.47 | 18.22 | 16.71 | 23.56 |
As of March 31, 2024. Returns are computed on a TWRR basis, net of fees & expenses, and not verified by any regulatory authority/SEBI.
Returns over one year are annualized. Benchmark changed from Nifty Smallcap 100 to BSE 500 TRI vide SEBI circular no SEBI/HO/IMD-PoD-2/CIR/2022/172 dated 16 December 2022.
Source: Nuvama Custodian Services, Equitree Capital[1].
Even after this performance, the median valuation of our portfolio is 16× FY25 and is expected to see a median profit growth of 24% in FY25. This leaves significant upside still to happen in our portfolio companies.
The last quarter — more particularly the last couple of months — has seen some consolidation / profit booking, leading to a negative return of 5.37% during the quarter. This is in line with what we wrote in our December 2023 newsletter, where we anticipated drawdowns given the quick pace at which markets had run up.
Over the past two months, we’ve witnessed notable volatility — the Nifty Smallcap 100 declining 15.6% from its 52-week high and the Nifty Microcap 250 down over 17%. This has heightened the conversations around a simmering “bubble” in the market, further accentuated by the SEBI chair’s endorsement that there is indeed “froth” in some pockets.
Takeaway
While valuations in certain pockets — more particularly the SME Exchange and certain larger mid / small caps — are indeed beyond comfort zones, our genre of companies is still reasonable, trading at its 10-year average with no sign of excesses.
For ready reference, here is the valuation snapshot we shared in our December 2023 newsletter — and the relative positioning still holds:
| Market Cap Range (₹ in crores) | No. of Companies | Median Current P/E | Median 10-Year P/E | Premium |
|---|---|---|---|---|
| More than 50,000 | 145 | 44.2 | 36.8 | 20% |
| 20,000–50,000 | 133 | 51.7 | 39.4 | 31% |
| 5,000–20,000 | 341 | 40.7 | 36.1 | 13% |
| 200–5,000 | 1,109 | 31.9 | 30.0 | 7% |
Median current P/E vs median 10-year P/E by market-cap bucket — snapshot from December 2023 newsletter. Source: Ace Equity, Equitree Capital[3].
“One thing that will always play out is — stock prices are slaves to earnings in the long run.”
01Where Is the “Bubble”?
One of the key reasons market men are anxious about a “bubble” is that current absolute valuations seem to be in a similar range to 2017 — reminiscent of the massive drawdowns that followed the unprecedented Small Cap run-up into 2017. Memories of the Nifty Small Cap Index plunging ~67% from Jan 2018 to March 2020 is what has people asking: will this time be really different?
We did a lot of data crunching to analyse whether this time is indeed different. Our thoughts:
1ASharp Drop in Earnings Post-2017 Led to the Sell-Off — Not the Absolute Valuation
Valuations are always forward-looking, in anticipation of earnings growth. Coming on the back of handsome GDP growth in 2016 and 2017, the expectation was that corporate earnings would continue to grow — leading into the absolute valuations. However, what followed post-2017 was an unprecedented slew of regulatory changes aimed at cleaning up the economy, which completely capsized GDP and corporate profits:
| Year | GDP Growth |
|---|---|
| 2016 | 8.26% |
| 2017 | 6.80% |
| 2018 | 6.45% |
| 2019 | 3.87% |
| 2020 (COVID) | -5.83% |
Downward Spiral: Four years of GDP on a rollback rampage. Source: MOSPI; Equitree Capital[3].
| Segment | CAGR PAT 2017–20 |
|---|---|
| Large Caps | 1% |
| Mid Caps | -6% |
| Small Caps | 0% |
| Micro Caps | -38% |
Corporate PAT CAGR 2017–20, by market-cap segment. Source: Ace Equity, Equitree Capital[3].
For ease of reference, the corresponding median P/E history by segment confirms the same story — multiples de-rated from 2017 through 2020 as earnings collapsed, before re-expanding only as profits returned:
| Median P/E | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | TTM |
|---|---|---|---|---|---|---|---|---|
| Large Cap | 33 | 30 | 28 | 32 | 37 | 36 | 37 | 41 |
| Mid Cap | 35 | 27 | 26 | 32 | 39 | 39 | 44 | 48 |
| Small Cap | 33 | 20 | 16 | 20 | 26 | 23 | 32 | 33 |
| Micro Cap | 27 | 16 | 11 | 16 | 18 | 18 | 26 | 28 |
Median P/E by market-cap segment, 2017 to TTM. Source: Ace Equity; Equitree Capital[3].
It was this substantial degrowth in earnings which led to the fall in the Small and Micro Cap segment — not the absolute valuations.
The Five Regulatory Shocks That Choked Earnings (2016–2020)
02Current Backdrop Seems Poised for Buoyant Earnings — PEG of 1.25–1.50 Doesn’t Suggest a Bubble
Amidst the global chaos of slowdown, inflation, interest rates, and geopolitical issues, India today is consensually looked upon as a beacon of hope, growth, and stability. Right from very strong macros to the push for emerging as a credible manufacturer to the world, the Indian economy and corporate earnings seem poised for handsome growth in the coming years. We deep-dived into the hard data to get further conviction:
2ACapital Expenditure at an All-Time High
Capital expenditure has increased four-fold in the last 8 years, from ₹2.5 lakh crore to ₹10 lakh crore by FY24. The government has allocated ₹11.1 lakh crore as capex for FY25 — a 10% YoY increase[4].
Watch
The government’s continued emphasis on capital expenditures supports the anticipated growth in the medium term — a 19% CAGR increase[4].
| In ₹ Lakh Cr | FY16 | FY17 | FY18 | FY19 | FY20 | FY21 | FY22 | FY23 | FY24 | CAGR |
|---|---|---|---|---|---|---|---|---|---|---|
| Capital Expenditure | 2.5 | 2.8 | 2.6 | 3.1 | 3.4 | 4.1 | 5.9 | 7.3 | 10.0 | 19% |
| Grant-in-aid for Capital Assets | 1.3 | 1.7 | 1.9 | 1.9 | 1.9 | 2.3 | 2.4 | 3.3 | 3.7 | 14% |
Central-government capital expenditure and grant-in-aid for capital asset creation, FY16 – FY24, in ₹ lakh crore. Source: Budget documents[4].
2BCapital Goods Cycle Has Turned
The capital goods segment grew at 9% CAGR pre-COVID. Post-COVID, it is expected to grow 13–15% CAGR until FY26, with a tracked 14% CAGR observed across FY17–FY23[5].
Q1–Q2 will see fulfilment of existing orders. Post-Q2, growth will be led by continued government infrastructure outlay, anticipated revival in private capex, PLI-led investments, EV infrastructure, and data-centre-related investments. PLI-fuelled capex is projected to peak by FY26, with private investment poised to take the baton thereafter.
Capital Goods Production — 9% CAGR Pre-COVID Becoming 14% CAGR Post-COVID
Production volume (₹ ’000 Cr, left axis) vs share of manufacturing output (%, right axis)
Capital goods production (₹ ’000 Cr)
% of manufacturing output
Capital goods production has accelerated from a 9% CAGR (2017–19) to a 14% CAGR (2021–23). Source: Ministry of Heavy Industries; Economic Survey of India[5].
2CGross Fixed Capital Formation at 35% of GDP — Highest Since 2009
Gross Fixed Capital Formation (GFCF) is an important facet of GDP growth — a barometer of the production of productive assets within the economy.
During the last mega bull run of the 2003–2007 cycle, investments grew faster than consumption and the capex boom led to acceleration in productivity, job creation, and income growth. Investment-to-GDP rose from 27% in FY03, peaking at 39% in FY08. Today, the ratio has reached 34%, with room to expand further[6].
In Focus
GFCF has grown from a low of 30.7% of GDP in FY15 to 35.3% in Q2 FY24 — the highest level of asset formation in the Indian economy since 2009[6].
| GFCF (₹ Cr) | 2014-15 | 2015-16 | 2016-17 | 2017-18 | 2018-19 | 2019-20 | 2020-21 | 2021-22 | 2022-23^ |
|---|---|---|---|---|---|---|---|---|---|
| GFCF | 32,78,096 | 34,92,183 | 37,87,568 | 40,83,079 | 45,40,509 | 45,92,579 | 42,55,689 | 48,78,773 | 54,34,691 |
Gross Fixed Capital Formation (GFCF), absolute values in ₹ crore, FY15 – FY23. ^FY23 figures are provisional. Source: MoSPI[6].
2DCorporate Profit-to-GDP Ratio Likely to Cross 8%
The listed corporate space’s PAT/GDP ratio has risen to 4.7% on a TTM basis and is on course to exceed 5% by FY25 (ICICI Securities). Per Morgan Stanley, the growth trajectory is expected to continue and could reach 8% over the next 5 years[7].
Net Profit as % of GDP
Listed-corporate PAT / nominal GDP, FY00 – FY24E
Net Profit / GDP
Annual anchor points traced from the source chart (ICICI Securities). Peak 6.4% in FY08, trough 1.6% in FY20, 4.7% TTM, 4.9% FY24E. Morgan Stanley flags 8% as feasible over the next five years[9].
2EUnlevered Corporate India Provides Huge Elbow Room for Growth
The Indian economy has undergone a significant structural transformation since 2017, resulting in enhanced company profitability, robust banks, and corporate balance sheets. This profitability surge coincides with a period where Debt/Equity ratios have hit a 15-year low[8].
| Median D/E | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
|---|---|---|---|---|---|---|---|
| Large Cap | 0.37 | 0.38 | 0.30 | 0.20 | 0.21 | 0.20 | 0.18 |
| Mid Cap | 0.27 | 0.20 | 0.17 | 0.16 | 0.11 | 0.11 | 0.13 |
| Small Cap | 0.42 | 0.32 | 0.30 | 0.31 | 0.22 | 0.20 | 0.21 |
| Micro Cap | 0.45 | 0.41 | 0.37 | 0.32 | 0.25 | 0.23 | 0.21 |
Median Debt/Equity ratio by market-cap segment, 2017 – 2023. Every segment has de-levered through the period. Source: Ace Equity, Equitree Capital[8].
This favourable scenario presents an opportune moment for companies to leverage their strengthened financial positions and embark on expansion initiatives. As companies capitalise on this improved leverage capacity, it is expected to catalyse private capex activities — further stimulating economic growth.
Risks to Monitor
While all stars look aligned for a super earnings growth trajectory, one needs to be watchful for risks that may hit the juggernaut:
Takeaway
Capex up 4×, GFCF at 35% of GDP, D/E at a 15-year low, PAT/GDP heading to 8%. This is the opposite of the 2017–20 setup that broke the previous Small Cap cycle. The macro backdrop today is built for earnings, not for a bubble.
“Individual stocks may obviously pursue courses widely dissimilar.”
03Broader Headline Numbers Distort the Story — Going Granular Has to Be the Theme
We think the entire conversation about valuations getting heated at the index level is a bit stretched for a couple of reasons:
3ACAGR Growth of Market Cap and Profits, FY2017–24
| Segment | MCAP CAGR | PAT CAGR |
|---|---|---|
| Large Cap | 17% | 15% |
| Mid Cap | 16% | 9% |
| Small Cap | 11% | 13% |
| Micro Cap | 9% | 9% |
CAGR of market cap and PAT across segments, FY2017–24. Source: Ace Equity, Equitree Capital[3].
3B% of Companies by PAT CAGR Bucket
However, as one gets granular, the data presents a completely different story:
| % of Companies Reporting PAT CAGR | Large Cap | Mid Cap | Small Cap | Micro Cap |
|---|---|---|---|---|
| 10–20% | 43% | 39% | 26% | 21% |
| 20–30% | 18% | 17% | 13% | 10% |
| 30–40% | 10% | 5% | 6% | 8% |
| 40–50% | 1% | 4% | 3% | 4% |
| 50% & above | 5% | 3% | 11% | 8% |
Distribution of companies by PAT CAGR bucket (2017–24), by market-cap segment. Source: Ace Equity, Equitree Capital[3].
When we look at the overall microcap segment, it shows a PAT growth of 2% — whereas more than half of these companies have posted PAT growth of more than 10%. A substantial 20% of the companies from each segment have achieved PAT growth of more than 30%[3].
3CSlicing Within Our Focus Sectors
Manufacturing Segment
| Segment | MCAP CAGR | PAT CAGR |
|---|---|---|
| Large Cap | 15% | 14% |
| Mid Cap | 17% | 12% |
| Small Cap | 14% | 14% |
| Micro Cap | 9% | 9% |
Manufacturing segment CAGR, 2017–24. Source: Ace Equity, Equitree Capital[3].
Consumer Segment
| Segment | MCAP CAGR | PAT CAGR |
|---|---|---|
| Large Cap | 16% | 14% |
| Mid Cap | 10% | 9% |
| Small Cap | 14% | 14% |
| Micro Cap | 8% | 12% |
Consumer segment CAGR, 2017–24. Source: Ace Equity, Equitree Capital[3].
Over the last six years, aggregate profits of this segment have doubled, and the median P/E of the microcap segment aligns closely with 2017 levels — sustained valuation stability. 46% of consumer segment companies have witnessed a doubling of PAT over six years; 22% have posted >30% PAT CAGR in the microcap segment.
Infra Segment
Large write-offs / negative performances of a few companies in the pack distort the picture for the entire pack with negative growth during FY17–24. However, one of our own portfolio companies in the Infra segment has seen its profits triple over this period — and there are a quite a few similar names where ground-up stock picking finds outliers in a pack showing negative numbers.
Takeaway
In hindsight, the Micro Cap segment on an overall basis looks pale in growth — almost making the pack itself un-investible. But ~20% of the companies across each of our focus segments have reported CAGR growth of over 30%+ over the last six years. Only by being focused enough to plough into this segment and invest in some of these top-quality businesses does the alpha generation become substantially different. This is exactly what we did at Equitree to deliver CAGR returns of 55.53% over the last 4 years[1].
“The daily blips of the market are, in fact, noise — noise that is very difficult for most investors to tune out.”
04Outlook for FY25
After a fast-paced rise in markets during Apr–Dec ’24, we were expecting profit booking — budgeting for a 3–5% correction in the index and 20–25% drawdown in small caps.
We indeed got a brief corrective phase: 75% of companies saw a drop of more than 10%, 60% by more than 15%, 43% by over 20%, and 28% by more than 25% from their respective 52-week highs over the past couple of months. However, the markets have seen an equally quick and swift recovery in April’24, earning back a lot of the correction already.
We had expected some time correction as well for stocks to consolidate, which hasn’t happened. This gives us a feel that we may still experience another round of absolute / time correction in the 1st half of FY25 as election results, geopolitical, and global issues roll out. However, we believe earnings buoyancy and liquidity should take over in the 2nd half of FY25, laying the foundation for another bull run over the next couple of years.
Overall, we believe FY25 will be a year of ground-up stock picking for alpha generation, with the broader markets giving high single-digit or lower-teens kind of returns. One could also see profit booking happening in segments where valuations have built in high order books while challenges of execution get experienced in FY25. Sector rotation should see money chasing businesses with growth visibility still trading at reasonable valuations — that’s again where bottom-up stock picking will come about.
Takeaway
In this light, we remain confident of our portfolio companies as they unfold another year of high growth. We expect profits of our portfolio companies to grow ~24% in FY25. Given the portfolio still trades at a mere 16× FY25 PAT, we strongly believe we should continue to see significant wealth creation. Any potential correction should be leveraged by investors to build up on the portfolio as we enter a multi-year growth story.
For any feedback or further information, please reach out to us. Follow our LinkedIn page for ongoing updates on our performance and market insights.
Sources
- 01
Nuvama Custodian Services; Equitree Capital internal performance and NAV records (March 31, 2024). Returns are TWRR, net of fees and expenses, and not verified by any regulatory authority/SEBI.
- 02
PMS Bazaar / APMI — top-10 PMS rankings across all strategies for FY24, observed across multiple time-frame buckets.
- 03
Ace Equity; Equitree Capital — segment-wise market cap and PAT growth data for Indian listed companies, classified by Large/Mid/Small/Micro buckets, FY2017–FY24.
- 04
Ministry of Finance / Union Budget — central capital expenditure outlay growth FY16 to FY25, including 19% CAGR observation through the period.
- 05
Ministry of Heavy Industries; Economic Survey of India — capital goods production growth pre- and post-COVID, with FY26 guidance band of 13–15% CAGR.
- 06
CEIC; RBI — Gross Fixed Capital Formation as % of GDP across the FY15–FY24 cycle (peaked at 39% in FY08; reached 35.3% in Q2 FY24, highest level since 2009).
- 07
ICICI Securities; Morgan Stanley — corporate PAT-to-GDP ratio (4.7% TTM, on course to exceed 5% by FY25; potential 8% over next 5 years).
- 08
Ace Equity — Debt/Equity ratio of corporate India at a 15-year low (FY24).
- 09
ICICI Direct Securities — Net Profit as % of GDP for the listed Indian corporate sector (TTM, current trajectory).
Disclaimer
This newsletter is prepared by Equitree Capital for informational purposes only and is directed at existing investors of its Portfolio Management Services. It does not constitute investment advice, an offer, or a solicitation to buy or sell any securities.
Past performance is not indicative of future results. Returns are computed on a TWRR basis, net of fees and expenses, and are not verified by any regulatory authority. Individual portfolio performances may vary. Forward-looking statements are subject to risks and assumptions that may not materialise.
Investments in small- and micro-cap equities carry higher volatility, liquidity, and business-specific risks, including the possible loss of principal. Equitree Capital is a SEBI-registered Portfolio Manager. Recipients should consult their independent financial, legal, and tax advisors before making any investment decisions.
This document is private and confidential. It may not be reproduced, redistributed, or published, in whole or in part, without the prior written consent of Equitree Capital.
Equitree Capital Advisors Private Limited