India Strategy - Yield and growth curves indicate ‘sweet spot’ for stock picking within diverse economic activities - ICICI Securities
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Yield and growth curves indicate ‘sweet spot’ for stock picking within diverse economic activities!
* Inverse correlation between growth expectations and earnings yield indicates largely rational expectations: Earnings yield curve and earnings growth curve indicate an inverse correlation between the two factors, thereby reflecting a largely rational behaviour (higher the growth expectations, lower the yield). We have considered the largest player within each industry for calculating the yield (consensus FY24E) and growth expectations (consensus FY22E-FY24E CAGR) as they are the bellwethers of their respective sectors. Also, being large caps, their price discovery is much better as is the quality of consensus estimates; this avoids the noise created by idiosyncratic cases of outlier growths and yields.
* Irrationality possible at extreme ends of the earnings yield curve. Directionally, the correlation of expected growth and earnings yield appears rational; however, due to excessive ‘optimism’ as well as ‘pessimism’, the extent to which the correlation is pushed creates irrationality at the extremes of the earnings yield curve. For example, on the low-growth side of the spectrum (10% (energy, power etc.), which is a significant spread over the 10-year bond yield (bonds are ‘zero growth investments’ with annual coupon payments remaining flat while high-yield industry leading stocks are still growing albeit at a low rate). On the other extreme, some of the growth stocks have negative or <1% earnings yield, which is an indication of high optimism by investors leaving very little ‘margin of safety’.
* ‘Sweet spot’ visible in the earnings yield – growth curve (FY24 earnings yield ≥ 5%; FY22-24 earnings CAGR >13% or nominal GDP). Key sectors where the bellwether stock’s earnings growth expectations over FY22E-FY24E will exceed or keep pace with nominal GDP growth of around 13% while yielding around 5% or above fulfill our criteria of being attractive. Current environment of earnings upgrade cycle provides additional comfort on the sustainability of the consensus earnings growth estimate over FY22-24.
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