Good News! Earnings Are Turning Around... Slowly - The 5 Minute WrapUp by Equitymaster
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Good News! Earnings Are Turning Around... Slowly

Nov 13, 2018

Editor's note: Dear reader, the sentiment in the market is not good if you're a trader. But if you're an investor... things are a lot better. There are safe stock opportunities you can take advantage of. Take the example of the current earnings season. Corporate earnings have been on a slow path to recovery, but the market is not in a forgiving mood. Any company, even a good one, missing its earnings estimates is being taken to the cleaners. The market may be nervous and impatient, but I believe the slow earnings turnaround is good. It creates many buying opportunities in safe stocks. Read on to know more...


Tanushree Banerjee, Editor, The 5 Minute Wrapup

Being part of a herd worked well for our earliest ancestors. It was probably the best and only way to survive attacks from predators. And it may take many more generations for human beings to shed that notion.

To this day, the elders in the family insist that youngsters follow religion, pursue education, take up jobs, and get married as per the family tradition. All with the purpose of staying part of the herd and staying safe.

But thanks to Buffett, Munger and other value investing gurus, the herd mentality is considered a sin in investing.

Every financial bubble known till date, starting with the tulip bubble, has its origins in the herd mentality. Yet people get trapped in it time and again.

So, you have heard stories of investors who found comfort in Harshad Mehta stocks in the early 1990s. Then dotcom stocks in 2000. And then real estate and infrastructure stocks in 2007. The herd mentality was that no one wanted to be left behind when everyone else around them was making money in these stocks. And the consensus about the rising stocks amongst the herd members, made everyone comfortable about them.

Now, there is also a herd of investors and traders who look for cues in quarterly earnings performances. And every sign of turnaround offers them reason to trade the stock.

But few of them look at such turnarounds in the context of fundamentals of these companies over several years.

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For instance, there's hardly anyone asking questions like...

  • When was the last time a large group of bluechips across sectors reported a big improvement in profit growth?
  • Was this profit growth a result of better capacity utilization or higher pricing?
  • Was this profit turnaround followed by a revival in capex?
  • Was this profit growth seen at a time when interest rates were near the bottom or near the peak?

Seeing the earnings revival, in the context of answers to these questions, would offer the signs of a real turnaround, if any.

As per the Business Standard, over the last 10 years, corporate India's earnings (growing at 4.1% for listed companies) has failed to keep pace with India's nominal GDP (growing at 12.9%).

When I look at the recent trend of earnings revival, in the context of the companies' long-term performance, the turnaround seems small.

However, keep in mind that a slow turnaround is good and more sustainable. Especially since we are expecting a big change in the macro scenario of global trade, interest rates, commodity prices and exchange rates.

A slow turnaround will force companies to re-think their capital allocation plans. They will direct their incremental profits to the most productive use. And in the process, maximize shareholder wealth, over the long term.

So, do not be in a hurry to buy stocks that have performed brilliantly in latest quarter's earnings. Nor dump the ones that have under-performed. Rather, review their performance in the context of what they have done over several years.

This will not just help you evade the pitfalls of herd mentality. But possibly allow you to be the investor of the next decade.

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Chart of the Day

The quarterly earnings is a misnomer. But can investors expect a reflection of the earnings recovery instantly in the stock price?

Well, the market is certainly myopic. There is typically a big contrast between quarterly and annual earnings performance of companies and the extent to which they find favour among investors.

Over the last two months, for instance, stocks of companies that showed earnings recovery in September quarter, were as beaten down from 52-week highs as the stocks that underperformed in earnings. Beware of following such herds.

Instead, stick to the best safe stocks in the market.

Follow the Quarterly Result Investing Herd at Your Own Risk

Warm regards,
Tanushree Banerjee
Tanushree Banerjee
Editor, The 5 Minute WrapUp

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