Monday April 9, 09:00 AM
Stockmarkets: Look beyond the quarter |
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By Equitymaster.com
This article was originally written in September 2004. The original draft, in its entirety, has been retained here while necessary updations have been made to the same.
The March 2007 result season begins this week with Infosys, the tech bellwether, slated to announce its results on April 13th, Friday. While this round of quarterly results may or may not provide any sense of direction to the currently volatile markets, they shall again test the patience and discipline of long-term investors, who will be bombarded by 'all' kinds of news flows regarding 'underperformance' and 'outperformance' of companies.
In the past, we have seen Infosys, one of the better-managed companies in India, being punished just because the management lowered the growth outlook (how many managements actually do that!). The stock tumbled by almost 30% in a single day. Given this kind of interest, we thought it would be useful to highlight what to look for in a quarterly result from an investor's standpoint? Here are the do's and the don'ts.
Seasonality and cyclicality: Some sectors are cyclical and seasonal (consumer sectors, paints, engineering) in nature and therefore, financials have to be appropriately compared. For example, on an average, the fourth quarter of the fiscal year contributes to as high as 40% of BHEL (BHEL.BO, news) 's full year revenues. Without going into the complexities of accounting methods, engineering companies generally tend to book revenues upon the completion of a project, which happens towards the end of the year. It is for this reason that the revenue contribution of the fourth quarter is important.
Similarly, paint, automobiles and durable sales are seasonal in nature (sales are higher during festive seasons).
QoQ and MoM: Drawing from the previous point, at times, it is popular in the stock market circles to estimate quarter-on-quarter and month-on-month growth i.e. estimating the number of cars sold in the third quarter with the second quarter of the same fiscal year as a base. Quarterly projections of company's financials and monthly sales volume projections have practical difficulties. For instance, month-on-month comparisons of auto sales could throw a totally wrong picture because of seasonality.
At times, the company, on a QoQ, may post a slower growth than 'expected' and the stock is punished. In this context, investors would be better off if less importance is given to jargons like 'above expectations', 'below expectations' and 'inline with our estimates'. Quarter-on-Quarter comparisons could be useful while analyzing those sectors where the demand-supply dynamics are not highly seasonal or cyclical (say, software).
A quarter is just three months: As we mentioned earlier, what quarterly performance does is enabling long-term investors to stay 'updated'. Though a long-term investor is unlikely to change his view on a stock based on just a single quarter's performance, if there are some concerning factors, it will enable the investor to re-look the assumptions based on which the investment decision was taken in the first place. Even here, analysis of the last four quarters will give a much broader picture than a single quarter. In fact, the longer one goes into the past, the better it is.
The issue of annualizing: It is common practice among investing circles to annualize quarterly performance in order to estimate what the full year numbers would look like. For example, if a company has reported earnings per share (EPS) of Rs 10 for the first six months in a fiscal year, it is easier to assume that the full year EPS will be Rs 20. But factors like seasonality and cyclicality may have been overlooked and this may distort the picture.
Some other checklists...
During mergers/de-mergers and acquisitions, the YoY change in net profits may be distorted. So, comparisons on a like-to-like basis will show the true picture. Most of the top rung corporates that are investor friendly tend to provide investors with this information.
There are corporates who revise the previous year financial numbers so that the current quarter numbers growth rate 'pleases' investors. It is therefore, important to read the notes to the quarterly results and understand if there are accounting policy changes. We feel that there is a strong requirement from the regulator as well as from the corporate side to take measures to curb this kind of a practice of consistently revising past numbers. Globally, accounting scams have eroded wealth of shareholders and hope we do not have similar situation in the future in India.
Though the quarterly performance of some corporates may show a decline in net profit, it is also important to understand what happened in the same quarter in the previous year. What if there was some extraordinary income due to a sale of asset in the previous year? In this case, analyzing the results by excluding the extraordinary items will show the true picture.
To conclude...
Management's work with a ten-year view: The long-term objectives of the company do not change every quarter. Credible managements typically devise business plan with a long-term view. Though 'long-term' may be one year for stock market circles, 'long-term' is typically ten years for corporates. While managements might spell out short-term (quarterly, half-yearly, or yearly) plans, investors need to find out that these fit into the long-term objectives of the company.
Judging corporate performance on a quarterly basis also exercises pressure on the management to resort to short-term measures, which may prove to be expensive from a long-term standpoint. It is also the responsibility of shareholders to tone down expectations and allow corporates to move the company towards its long-term objective of creating wealth for shareholders. Over a period of time, this will enable investors to differentiate the wheat from the chaff.
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