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Fundamentals vs expectations - Views on News from Equitymaster
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  • Jul 21, 2003

    Fundamentals vs expectations

    Last week was witness to some correction on the bourses. Profit booking was seen in most of the sectors. However, profit booking is necessary for a healthy bull market to sustain as some amount of profit taking encourages investors, who missed the rally earlier, to enter at marginally lower levels. However, not all of the weakness is due to people deciding to take some money home. Much of this is generated by the temporary panic or euphoria over the quarterly numbers declared by companies. This leads to volatility, which is definitely not good for retail investors.

    In case of software stocks, it is quarterly results announcements, which decides the fate of their stock market performance in the short term. After the declaration of quarterly results, the company's stock price gets aligned to the earnings growth and guidance given by the companies. However, what is of surprise sometimes is the "domino effect", which overtakes investor sentiments and leads to a chain reaction in the software sector. Many a times, stock prices of companies register huge gains, defying all fundamentals that are necessary to justify the rise in the stock price.

    To put the above point in perspective, below is discussed a small example, which may not be true in all the cases but then, it is not even false all the time.

    The charts above show the stock price movement of three scrips viz. Infosys, Wipro and Mastek. The charts show the stock price movement of these stocks in two periods. First, the difference in the price of these stocks in the period 'a day before and after the declaration of Infosys results', the industry stalwart whose results decide the outlook for the software sector. Second is the change in the stock price 5 trading sessions post Infosys' results. Though this is a very short-term scenario, it is just an attempt to bring forth the fact that volatility could have adverse effects on retail investors.

    The chart above (In bad times...) shows the fall in stock prices of these three stocks when Infosys gave a much below than expected guidance for FY04, which led to tech stocks taking a beating on the bourses. But, as can be seen, in the next 5 sessions, Infosys managed to recover some lost ground. However, Wipro and Mastek continued to remain out of favour. Here, management and fundamentals seemed to have led to some recovery in the Infosys stock. Similarly, when Infosys upped its guidance in the June quarter, all tech stocks shot through the roof on the back of Infosys' guidance (see chart: and good!)! However, soon, reality set in and the declaration of quarterly numbers by other software companies re-aligned them to what they deserve.

    We observe that the performance of software stocks post Infosys' result announcement is a function of Infosys results. This means that there is a considerable amount of expectations build up by investors towards other software stocks, after Infosys declares its results. Investors need to understand that in the long term, fundamentals and not expectations guide stock prices. So, wait for the results to be declared and then take an investment decision. Though there may be short-term volatility, as traders get in and out of stocks, hold on to fundamentally sound companies. They are surely to come out of the trough, sooner or later.



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