Strong Earnings, Lost Returns: The De-rating Trap — SkimNews
Get the Finance newsletter
Daily finance — markets, central banks, M&A, the prints that move money. Free.
- Carnelian Asset Management & Advisors analyzed 272 BSE 500 companies with 10+ years of trading history and found 110 de-rated by 5% or more between March 2016 and March 2026
- De-rated firms grew profits at a 15% CAGR while market capitalisation grew at only 10% CAGR, against 162 re-rated peers that posted a 12% profit CAGR and a 17% market-cap CAGR
- HDFC Bank compounded profits at roughly 20% between 2019 and 2026 yet delivered a negative 5% stock return, illustrating how valuation compression can swallow earnings growth
- Carnelian coined the term "MAGIC" for companies where earnings growth and valuation expansion work together, and warned that avoiding de-rating matters as much as finding those winners
- Triggers for simultaneous earnings and valuation declines include stronger competition (the letter cites Jio's entry reshaping telecom industry economics), regulatory changes, governance concerns, and large acquisitions or heavy capex
- Heavy institutional ownership — about 83.5% in HDFC Bank — can leave fewer incremental buyers to push valuations higher, Carnelian argues
Why it matters: Investors who chase high-profit-growth names without checking valuation multiples risk buying into de-rating traps: roughly 40% of long-tenured BSE 500 firms in Carnelian's sample saw their multiples erode even as profits compounded, turning a 15% profit CAGR into just a 10% market-cap CAGR over the decade — meaning entry valuation, not growth quality, often determines whether shareholders actually make money.
Ask SkimNews
