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Impact of Earnings Growth on a Company's Share Price
Nov 22, 2018

As I mentioned above, the market price of the stock is a function two factors i.e. earnings growth (Earning Per Share) and the earnings multiple (Price to Earnings Ratio).

Re-rating of a company (an increase in the PE Ratio) along with earnings growth (rise in EPS) will have double positive impact on the stock price.

But what has moved the needle for the top stocks in the past decade?

Is it the earnings or the perception of earnings?

A look at the top five stocks by market capitalisation over a decade says actual earnings play a major role in the stock price.

A 110% earnings contribution for HDFC Bank implies 110% of the share price contribution is due to earnings growth with the negative 10% due to PE de-rating.

Except for HUL, which has been re-rated along with the whole consumer products space, others have grown mainly on strength of their earnings.

A company that has been massively re-rated i.e. grown mainly on perception (PE Ratio), rather than its earnings strength, might fail to do so in the future.

On the other hand, a company might have been de-rated in a pessimistic environment despite strong earnings growth.

Such companies can benefit from the dual advantage of a re-rating and growth. Those are the companies you need to look for.

Data Source: BSE India, Ace Equity

This Chart Of The Day was published in The 5 Minute WrapUp - Of These 2 Types of Stocks, Which One Would You Pick?

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