Nifty/ Economic Outlook

Hi Guys,
Many people believe the Nifty may go and make new highs after the corporate tax cut.

I am not sure what will happen.

However if we reverse the corporate tax cut, why was the market going down ??
NPA's in banks and NBFC or low demand for the Auto Sector or just a slow down??

Whatever it was it wasn't because the corporations were paying high taxes

Lets say company 'A' makes a product that it sells for Rs: 500 and has a profit margin of 20%, i.e. Rs:100 as profit.
This company pays 35% tax before the tax cut and now will pay 25% taxes i.e. Rs 25 of the 100 instead of Rs 35
The company earns Rs 10 more as the bottom line.

So if you owned the company, you now make Rs 10 more every year. That would mean you earn Rs 75 instead of Rs 65, which is around 15% increase in income. So the owner of the company will see a large increase in income.

But if the Rs 10 is used as a discount and the product of Rs 500 is discounted to Rs 490.. it isn't all that attractive. Say you go to buy a T-shirt or you go for dinner at a restaurant or order a pizza. A discount of Rs 10 is not the factor in making that purchase.

The tax cut is a great step for business as a whole and investments but doesn't address whatever was causing the market to be sold off before the tax cut.
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PE ratio and valuations.

Lets say company A is listed on the Stock Market.

It sells a product of Rs 500 and has a profit margin of 20% i.e. Rs 100 and has a 35% tax.
So it has a net profit of Rs 65

The company trades at a PE ratio of 10 so Rs 650

The tax cut is announced and now the company has a tax rate of 25%.
So it will now make a profit of Rs 75

The company will still trade at the same PE ratio of 10, and is now valued at Rs 750
That is an increase of around 15% in stock price/market price.

We have already seen the market rise around 10%. Assuming all companies were not in the 35% tax bracket and some were lower, an average 10% increase in stock price/Market price is appropriate.
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What does this mean??

If company A makes the same number of sales Rs 500 it will make Rs 75 in profit and should trade at a PE of 10 i.e. Rs 750
But if it has lower sales say Rs 450 it will make Rs 67.5 as profit and should trade at a PE of 10 i.e. Rs 675

As I mentioned at the beginning corporate taxes even if passed down as a discount is not large enough to make it attractive. The earnings YOY is not a factor to drive the economy. If a company made Rs 65 last year and now Rs 75 it has a 15% YOY growth but the stock is already trading higher since the tax cut announcement which basically factors the PE multiple and YOY growth.

The only factor that is unaccounted for is Return on capital. As I will make more money on investing the same amount as earlier. We do see FMCG trading at 45+ multiples for this very reason. So a PE expansion is quite possible.

Hope this was an interesting read.

These are personal views and not financial advise.- Josh