What to make of Mr Market's reaction to EPS surprises... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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What to make of Mr Market's reaction to EPS surprises... 

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In this issue:
» Are oil companies' profits for real?
» Germany may now be under the downgrade hammer
» Clinical trials the new risk for Indian pharma
» Do Eurozone risks make US dollar's prospects brighter?
» ...and more!


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00:00
 
There is no differentiation between Apple and Infosys. At least not for Mr Market! An earnings surprise during the result season causes the gentleman to hyperventilate, irrespective of the stock! A surprise in quarterly earnings is subject to several factors. The change in the company's fundamentals is only one of them. The earnings (EPS) expectation as per the consensus of brokerages is as important. And the reaction of the market in terms of valuing the performance of the stock relative to its peers is the third factor. However, for Mr Market it's the herd mentality that reigns supreme. Whether or not the company's balance sheet is as robust as Apple or Infosys, failure to meet earnings guidance meets with outright dismissal. Furthermore, if markets are in a correction mode, even the slightest underperformance by fundamentally strong companies bruises their stock value. The opposite holds true when markets are buoyant. Irrespective of their intrinsic value, stocks fetch lofty valuations if they manage to beat market expectations. Even when some of it is laced with one-off or extraordinary incomes.

For long term investors though, the game of meeting quarterly expectation is nothing but agonizing. There are companies that cook up stories to convince investors that they are well on track. Lest investors dump them with the fear of not meeting expectations. There are other well meaning ones that declare their concerns upfront. Such honest admissions are not spared either. Companies of the likes of Marico have faced investor wrath for the mistake of airing their near term concerns about the business.

For value investors though, Mr Market's mood swings present nothing less than golden opportunities. All that they need to focus on is the intrinsic value of the stock. Unless the performance of the company is affecting its intrinsic value dramatically, there is no reason to doubt its potential. And if the valuations offer adequate margin of safety, the timing for buying the stock cannot be better! Mr. Ashwath Damodaran, professor of finance at NY University and one of the most profound minds in the field of valuation theories, has argued this very fact in his latest blog. We cannot agree more with him. But investors need to be very careful about their judgment of the quality of earnings and intrinsic value.

Do you think investors should react according to the market's reaction to earnings surprises during quarterly results? Let us know your comments or post them on our Facebook page / Google+ page.

01:30  Chart of the day
 
The country's tax revenues may not be rising in a spectacular fashion. But the Income Tax (IT) department is still doing everything in its power to raise the figures. They are doing so through the tax raids. In fact, the value of assets seized through raids has more than doubled in the last 5 years. And this is largely attributable to the 'big fish' or the creme de creme of the group of people in high tax brackets. The IT department has been helped by sophisticated technology that has come in aid to identify potential tax avoidance. As per Business Standard, the number of raids themselves has gone up to 5,260 in FY12, a rise of nearly 60% from 3,281 in FY08. Moreover, the undisclosed income admitted and assets seized by the IT department have gone into billions of rupees as seen in the chart. A good way for tax payers to avoid such raids and consequent penalties is simple. Just declare your income honestly and pay the due taxes.

Source: Business Standard


02:15
 
The oil under recoveries has long been cited as the bleeding wounds of oil refining companies (OMCs). However, under recoveries just being the notional losses rather than losses at the bottomline level, normally the situation for OMCs is not as grim as it seems. Investors therefore often fail to correctly judge the quality of earnings of the OMCs.

However, the year FY12 was different. The net earnings were mainly in red for the most part of the year. Until the Government came in as a last minute rescuer with cash subsidies announcement at the end of the year. But even after that the year has not ended well for OMCs. Four months past FY12, they are still waiting for cash compensation. And meanwhile the damage has been done. The companies are deep in debt paying huge interest expenses to meet working capital needs. Interestingly, any cash compensation will go back in Government's pocket as dividends as it happens to be the majority stakeholder in these companies. The only way to straighten the twists is to rationalize fuel taxes, something that no one seems to be talking about.

02:50
 
When one thinks of the Euro crisis, there is one nation that hardly comes to mind. Germany. Indeed, with its current account in surplus and public debt at not so threatening levels, Germany can certainly be considered as perhaps the only safe haven in Euro region. Not anymore though. Ratings agencies - who suddenly seemed to have found a new sense of purpose - have now put Germany's sovereign debt under review for a possible downgrade. And the reasons also seem to be valid. You see, German big banks have a sizeable exposure to countries like Spain and Italy. And thus if the latter were to go under, German institutions are also likely to suffer a great deal. And who knows, they might also require a bail out of their own. Thus, given this scenario, a debt review is certainly justifiable.

We cannot help but compare Germany's situation to that of China. Both nations grew their exports to phenomenal levels and then lent the same money to the countries they had a surplus with. And now with their debtors unable to pay, both of them are staring down a big hole. Perhaps it pays to not let exports become too big a part of one's economy.

03:29
 
Conducting clinical trials for potential new drugs is a tricky affair. They are absolutely essential if new drugs with better treatment ability have to find their way into the market. But the manner in which these trials are performed also become important. Business Standard has named some top MNC as well as domestic pharma companies. These were allegedly involved in clinical trials in which 438 persons died in 2011. Companies maintain trials are conducted on patients already in advanced stage of the disease. These are patients with little or no treatment options available. They have also maintained that standards applicable to trials in India are no different than what they are the US, EU or elsewhere.

Having said that, some amount of regulatory tightening will have to be considered. For starters, is the choice of a clinical trial site. Currently, clinical trials can be conducted anywhere with a medical supervision. This can be rectified by establishing certain criteria to be met before a particular site can conduct clinical trials. For new drug discovery research, clinical trials are an integral part of the entire research process. This is because data from these trials give an idea of the efficacy of the drug, whether it is a better option than drugs already available and the like. But pharma companies also need to ensure that they are ethical. And do not abuse moral obligations and the law in their scramble to launch new drugs in the market.

04:00
 
Say two houses are burning down. The only difference being that the fire in one of them is much bigger. But does this mean the other house is safe? Would you run into this house thinking it is a safe haven? Certainly not! But in a figurative sense, this is actually what global investors are doing. We are referring to the heavy indebtedness of the Eurozone and the US. The difference is just that the Eurozone is in a far worse shape. For the US, the only saving grace at the moment is that it has a national central bank and its own separate currency. It can repay its debt by devaluing the dollar. For the Eurozone, the task gets very complicated because no member country can print currency on its own. It requires consensus.

But does this make the future prospects of the US dollar any brighter? We certainly don't think so. The economy is slowing down. It is currently facing one of the worst droughts in its history. High food prices are set the drive consumer prices higher. Add to this situation a government that does nothing but add more debt. We are of the opinion that the US dollar is quite likely to undergo significant devaluation in the coming times. This, in other words, means that gold prices could scale much higher from the current levels. It would be best to have some portion of your investment portfolio to be invested in gold.

04:30
 
Indices in the equity markets languished in the red today on account of mixed set of results from India Inc. The BSE Sensex was trading lower by around 54 points at the time of writing. Commodity stocks were under the maximum pressure. Most Asian indices closed lower today with Europe opened on a positive note.

04:45  Today's investing mantra
"In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond" - Warren Buffett

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    Equitymaster requests your view! Post a comment on "What to make of Mr Market's reaction to EPS surprises...". Click here!

    1 Responses to "What to make of Mr Market's reaction to EPS surprises..."

    suresh

    Jul 26, 2012

    i think intrinsic value is an important & interesting concept to be looked into. The concept of herd mentality is very much prevalant in the so called "developing markets" where people simple go by some recommendations without understanding the business fundamentals & strength of the balance sheet. I think investors should take a balance sheet approach for investment decision even though P&L has an impact.The revenue guidance should be seen an indication due to unpredictable market scenario through out the globe. In the current scenario companies are finding it difficult to predict even the next month revenue & so much is the volatility prevails. Investment decisions should not be based on the guidances & small deviation as long as the companies have sound fundamentals & competitive situation to compete in the long run

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