0805

27 July 2009

New Delhi

When India's largest corporation, Reliance Industries (RIL), announced quarterly results on Friday, it changed a major statistic for corporate India: the combined turnover for companies which have declared results for the quarter ending June 2009 is now below the same number for 2008.

Profits have risen, though, by about 11%, largely on account of lower input costs, and in some cases, by a careful pruning of employment expenses (read jobs).

This parallels what has happened in the West, though there the turnover losses have been deeper, and profits, on aggregate have also dropped. Margins have improved, again as a result of manpower cuts and lower raw material costs.

Obviously, this is not the road to salvation - lower input costs cannot continue infinitely, and if you keep cutting employment strength, eventually it will impact potential output. And, at the macro level, it will reduce purchasing power in the economy. So, everyone is hoping like hell that the downturn will bottom out, perhaps as a result of governments rapidly printing money.

How this hope translates into share prices is a question we would all dearly like to be able to answer. If we project a 11% growth in profits as the trend line, then the current pricing of the Indian major indices, the Nifty and Sensex, is way too high. If, on the other hand, we believe profitability will rise, then there is room for upside.

I look at it this way - Indian companies have cut fat from their systems, and are hoping that the world economy will right itself. If it  does, and turnovers start rising, the danger will emerge on the cost side, with raw material prices rising. In that case, margins may shrink. 

On balance, the intelligent investor will view the RIL numbers as a flag of caution, and watch the Indian economy for more clarity, rather than jumping on the back of the recent upturn in stocks