Why many top profit-making companies lag in market cap?

Why many top profit-making companies lag in market cap?

The five MAMAA stocks – Meta, Alphabet, Microsoft, Apple, and Amazon – account for 22 percent of S&P 500’s market cap.  This dominance of mega corporations in market cap is a major trend in mature economies and this trend is catching on in emerging markets like India too. A structural shift in the Indian economy, which has gained momentum during the last decade, is the formalization of the economy. Reforms like the GST have hit the informal sector hard. The informal sector, which thrived on tax arbitrage, is finding the going tough in the highly competitive business environment. The inevitable consequence of this transition is the formalization of the economy.  The formal sector is steadily gaining market share at the expense of the informal sector. Consequently, the big is getting bigger with increasing market and profit share.

In 1991 when India started liberalizing its economy, the top 20 companies accounted for around 14 percent of India Inc’s net profit. This figure has been steadily rising. It rose to 52 percent in 2010 and now in 2022 the Top 20 mega companies account for around 75 percent of India Inc’s net profit.  But it is important to note that many highly profitable companies lag in market cap. This divergence between profits and market cap is significant.

India’s Top 20: Net profit & Market cap

Source: Capital Market Magazine

Market cap rank is as on 20^th October 2022.

What happens when the big get bigger?

The dominance of mega companies is a global trend which can be seen in mature market economies like the US and Japan and in rising economies like South Korea.  These mega companies have access to cheaper capital, superior human resources and the latest cutting-edge technology which will enable them to grow bigger and stronger. Also, their huge resources enable them to withstand shocks much better than others. Therefore, most of these highly profitable blue chips should continue to do well.

Why the disconnect between profits and market cap?

It is interesting to note that many companies in the Top 20 in profits do not find a place in the Top 20 in market cap. More important, many companies not in Top 20 in profit do find a pride of place in Top 20 in market cap. This is important since market cap largely indicates market’s perception.

A major disconnect between profits and market cap can be seen in the case of the Adani stocks. Gautam Adani has proven expertise in executing large infra projects; but the stratospheric valuations of Adani stocks are a matter of concern. PSU majors like ONGC and Coal India, though highly profitable, are not much fancied because they are perceived by the market to be in Sunset industries that deserve only a lower valuation multiple. Also, these giants had never been wealth creators for investors. NTPC and Power Grid also are not fancied by market as potential wealth creators. Tata Steel, JSW Steel, Vedanta and SAIL are cyclical commodity plays. SBI, though India’s largest bank, also doesn’t have a track record of wealth creation unlike some of the private sector majors. But SBI is doing exceedingly well now. The Bajaj twins, Kotak Bank, Asian Paints, and the IT majors have an enviable track record of incredible wealth creation which justifies their high valuation multiples and market cap. The crux of the argument is that more than current profits, it is the potential profit and market perception regarding the potential of these companies to create wealth that determines stock prices and returns to investors. Since the churn in Nifty is only going to increase in future, the potential entrants to the Top 20 should be keenly watched.

First published in The Economic Times