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Time to Rejoice With Infosys Results?

Jan 15, 2016

In this issue:
» The road ahead for Indian retail industry
» SEBI to tighten noose on rating agencies
» Market roundup
» ...and more!
0.00
Tanushree Banerjee, Co-Head of Research

Neither I nor my team members look at the market movement first thing in the morning. Even our daily market updates are never about where the market is headed during the day. Understanding or predicting short term market movements is clearly not our beat. But days like this, which follow major earnings announcements, are interesting.

Infosys which typically leads the announcement of corporate earnings every quarter tends to be a major influence on investor sentiments. It's under or outperformance is often immediately reflected in market movements. Also more often than not investors assume that they should set their broad earnings expectations in line with Infosys' performance.

The first fortnight of 2016 has been particularly painful for investors with no concern for earnings growth. Most stocks that have failed to sustain or boost profits in 2015 have been taken to the cleaners. Many have revisited not just 52 week lows but also April 2014 (pre-election) valuations. So every sign of better earnings performance, however meek, is welcome. And Infosys's results yesterday provided just that ray of hope to many.

Unfortunately, according to us, it is hardly the time to rejoice.

Investors must understand that there is a huge divergence in the earnings and valuations of bluechips and smallcaps. Bluechips of late have been laggards both in earnings show and valuations. While the smallcaps have had mixed performance on earnings front, have scorched their way ahead in terms of valuations last year. In fact, even in times of market mayhem, hundreds of smallcaps continue to trade at 52 week highs. This data from Economic Times is particularly worrying! As many as 462 of the 769 stocks in the S&P BSE smallcap index are trading at PE multiples higher than their averages of last five years.

Whether all of these will show up healthy earnings performance? We certainly don't think so. In fact we doubt how many of these will be able to stay resilient if macro headwinds turn for the worse. And if they don't, we would be staring at a bloodbath in smallcaps in the months to come.

My colleague Richa, being the editor of Hidden Treasure, looks at smallcaps far more closely than I do. And she is sending some fierce warnings to her subscribers this week. She is going to remind them that the BSE Smallcap Index had risen about 90% in four and half months leading up to the peak in Jan 2008. What followed is history. An unprecedented number of retail investors lost enormous amounts of money. Many of them never returned to the stock market.

So if you have put aside the earnings concerns of smallcaps stocks so far or are over exposed to them, it is time you take Richa's warnings seriously.

Have you reviewed the earnings performance of the smallcaps you own? Let us know your comments on post them on Equitymaster Club.


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3:00 Chart of the day

If CII - BCG (Confederation of Indian Industries and The Boston consulting Group) study is anything to go by, Indian retail seems to in good shape. As per the study, Indian retail sector is set to double by the end of the decade. And why not. The retail sector will get the fillip from demographic dividend that India has. Rise in nuclear families, rapid urbanization, more youth joining work force and rise in income levels will further drive consumption story. Does that suggest better times ahead for conventional retail companies in India?

Well, we believe one needs to be cautiously optimistic in this regard. Last decade has brought with it some sweeping developments that have changed the face of Indian retail industry, as we knew it, in an unthinkable way.

The rise of digital influence and e-commerce companies pose a big challenge and opportunity to the retailers. The latter will need to adapt to the change in the consumer behaviour that has been spoilt for choice and by heavy discounts, and keep pace with it. And this is not going to be an easy task with huge investments needed in building channels, supply chain and data, analytics and IT.

The chart of the day shows expected penetration of e -commerce across different product and service categories.

The Future of Indian Retail Industry

Some of the big retail chains have been nimble to adapt to these changes and have already gone online through e-commerce firms like Flipkart and Amazon. But the fight to survive and remain relevant does not stop here. These companies will need to work on strategies to not just exist, but remain viable. And this is what will differentiate winners from losers in the long run.

3:50

Over last few months, rating agencies have been in the news for all the wrong reasons. While things have been far from ideal in ratings business, what happened in case of Amtek Auto was a stern reminder of the magnitude of menace. And how it can rattle the faith of retail investors.

As analysts who believe in meeting managements before recommending companies, we have come across cases where managements have admitted to 'rating shopping'. Since rating agencies also get their businesses from businesses and companies they rate, there is a huge conflict of interest and credibility issues as well.

Thankfully, the market regulator is waking up to the need of putting things right. SEBI is likely to ask rating agencies to set up independent internal assessment teams. The latter will assess if the rating awarded is appropriate. This is likely to offer a second level of check to the way rating agencies work.

While there can be a genuine case where earlier rating given to a company needs to be downgraded, rating agencies have been indiscreet with their power. They have suspended or downgraded the ratings of a company several notches down. This has been done in a matter of days, not giving enough warning to unsuspecting investors. The poor practices at rating agencies may be checked as SEBI makes them accountable. The new norms for rating firms are likely to be released by for public consultation in next few weeks. Whether these are followed in spirit is something only time will tell. Nonetheless, the move by SEBI to tighten the noose is a step in the right direction.

4:15

The Indian stock markets after opening the day on a positive note, slipped below the dotted line. At the time of writing, the BSE-Sensex was trading lower by about 76 points (down 0.3%). Barring IT and oil and gas indices, all sector indices are trading in the red with auto and capital goods indices leading the losses.

4:45 Today's Investing mantra

"We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Richa Agarwal (Research Analyst).

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