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Good start to earnings season

Jul 12, 2000

In coming days corporates will walk down the earnings ramp, trying to impress the markets with their 'performances' and 'outlook'. The markets will take keen note. That the markets have failed to react to the strong financial posted by three corporate giants - Infosys, Satyam Computers and HDFC, is one thing. It seems such a performance was already accounted for in current valuations. But how will the markets react if a company were to either miss or exceed expectations.

Earnings growth is a key determinant of stock market valuations. Indeed, Warren Buffet in one of his rare discourses on stock markets counted this as one of the three things that he would look at to determine the course of stock markets (he was infact speaking of 'after tax corporate earnings to GDP', which in this case we relate to earnings growth).

Software companies command astronomical P/e multiples largely due to their fantastic growth rates (Infosys' net jumped 109%). This makes these stocks look not so expensive when one uses other valuation criteria such as the P/e-growth ratio. Therefore, if earnings growth were to falter, one can convincingly take a view that valuations will be headed lower.

Another important development has been taking place in the markets in recent years. Markets have been keen to look at companies more closely in terms of the quality of management and transparency of earnings among other factors while determining valuations. Therefore, we have the case of Zee Telefilms (and its web of subsidiaries), which fell sharply on the announcement of its results (it recovered a part of the losses in subsequent days). On the other hand companies such as HDFC, which despite growing by a more sedate 20% continue to be favored by markets. Earnings growth is one thing. Quality and transparency of the same is another (and needless to say a very important) thing.

The process of sifting is likely to move a step further this quarter. Expect markets to accord premium valuations to companies with a proactive and respected management, focused vision, strong financial performance and attractive business 'outlook'.

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