A bashing for predicting the Index - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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20 JUNE 2011


"There is a rule in our business", said a sympathiser, "that you never predict a number and a date."

The sympathy was being expressed in support of Meredith Whitney, a market analyst in the US who had predicted the collapse of Citibank prior to the Lehman crisis. In 2010, she made the "mistake" of predicting that there would be 50 to 100 defaults amounting to hundreds of billions of dollars in the municipality debt market (called "muni's") in USA in the year 2011.

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Well, that has not happened. The defaults of the "muni's" are nowhere near the scale that Ms Whitney had predicted. So her critics are out there questioning her analysis. Some have come to her defence and said that by her very act of warning of the defaults, Ms. Whitney had done a service of warning retail investors to stay away from the potential slaughterhouse of debt being issued by the big Wall Street firms (for big fees) for their potentially troubled city governments who badly need the innocent tax payers and savers to keep their cities afloat.

So the defaults, as such, may not have been big but Ms. Whitney helped save the sensible. And her research was right - and valid. Events may not have played out (i.e. the US government is still busy saving the big banks rather than shutting them down and the Fed is printing increasingly worthless US Dollar bills) but Ms. Whitney stands untarnished.

A Whitney bashing

The bashing I have received seems similar to that handed out to Ms. Whitney - what with a string of emails and comments (all available for you to read on the previous Honest Truth) bombarding me for committing the original sin: giving an Index number and a month by which it could get there.

Well, readers would do well to note all the caveats that are placed in the May 2011 article and the (June 2010 article) along with assumptions of foreign buying and earnings data.

Here is a comment from the May 2011 article highlighting a paragraph from the June 2010 article. "And I made this comment: Many others should note that a "prediction" of the Index is really a prediction of the direction of share prices in general, and don't get hooked on to a specific number like 19,000 or 21,000 by July 2010 or 30,000 by July 2012."

But there is another aspect of the article which drew in comments and I wish to address that.

There were suggestions that the data used in the column for the estimated (and actual) EPS numbers for the BSE-30 Index were wrong. One comment provided a link to an xl sheet housed in cyberspace with calculations of the level of the BSE-30 Index every March 31st and the EPS numbers. And these numbers were dramatically different from the data sourced by me from Bloomberg.

Some even suggested that the data sourced from Bloomberg was hype to mislead the foreign investors (through people like myself who may be in touch with them) and make them scapegoats in the next collapse of the Indian stock markets.

This "difference" in data and the accusations that I was using wrong data and misleading innocent investors deserves some introspection and analysis.

The game of numbers

To clarify, I don't mislead anyone. I give people my views and people are free to follow them or ignore them. Unlike many Wall Street firms (please see the movie ‘The Inside Job' - SEBI should make this film mandatory viewing for investors). And by the way, if I am wrong, my savings and investments in the Quantum Long Term Equity Fund will also lose value so, as the saying goes, "my money is where my mouth is".

And, yes, I have been wrong in the past on macro calls (I thought Prime Minister Manmohan Singh would give India an honest government) and on micro calls (we have owned stocks that we should never have owned). So, yes, I could get the Index level and the date wrong.

Table 1: Why are the "facts" of EPS so different?
Year ended March 31 Column A Column B Column C
  EPS for BSE 30 used in my column in May, 2011 sourced from Bloomberg BSE 30 EPS data from the BSE EPS for BSE 30 sourced from Bloomberg in June, 2011
2008 824 778 964
2009 792 773 785
2010 912 841 991
2011 1,124 954 1,132
2012 1,334 estimate No estimates 1,463
Source: Bloomberg and BSE

The EPS numbers used in Column A of Table 1 above are from Bloomberg and these were used in The Honest Truth in May, 2011. On checking with the Bloomberg fundamental research team, I was told "We use EPS Adjusted to calculate the index EPS. This equates to EPS before abnormal/exceptional/non-recurring items and excluding the XO (extra-ordinary) items disclosed by the company. Items we recognise as XO are: gains/losses caused by (1) natural disasters, (2) change in accounting principles and (3) discontinued operations. Unfortunately, brokers do not explicitly state what the XO items are in their reports. EPS is calculated on a consolidated basis."

Bloomberg looks at the "consolidated earnings" of the BSE-30 companies on a 12-month rolling basis. These are adjusted for any one-off items and provisions. As data comes in and as companies report their earnings, Bloomberg will dynamically change those reported EPS numbers. Note how Column C (also from Bloomberg) differs from Column A (data sourced from Bloomberg for the May 2011 column) even though the time gap in the data is only a few weeks.

The BSE analysts, meanwhile, are the authors of Column B. They prepare their EPS numbers on a stand-alone basis as reported by the company. There is no consolidation of any of the subsidiaries. There are no adjustments for any provisions or one-off items. And this data is as of March 31. So, for example, if HDFC has not reported its March 31, 2011 numbers to the BSE on March 31 itself, the BSE will NOT use this data. It will have data for the 12-months ending December 31, 2010 for HDFC and it will take that as the EPS number for working out the PE ratio of the Index as of March 31, 2011. And when the March 31, 2011 data is submitted to the BSE staff, they will not go back and change the "data as of March 31" for this update.

In both the approaches, neither Bloomberg nor the BSE change the data for any change in the companies that comprise the BSE 30. For example, the data for March 2008 will include the earnings of Satyam, since it was then a BSE 30 company. The data for March 2009 will not include Satyam but will include Sun Pharma which was brought in to replace Satyam after Mr. Raju got tired of riding his tiger.

So, all else being equal the EPS data for the BSE-30 for March 2008 and March 2009 have only 29 companies in common: the 30th company in March 2008 was Satyam and the 30th company in March 2009 was Sun Pharma.

Investors should be aware that there are various methods of calculating market data such as earnings and PE ratios. The best we can do is to use the same data source so as to be consistent in the inherent flaw that exists in a particular data source! But, seriously, thank you for the feedback on the earnings. After I managed to contact BSE and Bloomberg, I did request them to talk to each other and see if there is a way they can come to a common EPS and PER number for the Indian stock markets.

Meanwhile, like Meredith Whitney, I hope investors will act.

In this case, by being gentle but firm buyers of Indian stocks and not getting blanketed by all the bad news out there. I hope my optimism in predicting a higher Index (based on the realisation of the growth in earnings and the flows of foreign money) will give investors a chance to allocate some of their savings to stock markets.


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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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14 Responses to "A bashing for predicting the Index"

DD

Jul 7, 2011

Dear Ajit,
I think you are a smart and honest man in this complicated world of financial market full of convoluted people. But last two posting of yours has shaken up my belief.
First let me tell you about June Honest Truth. You presented the table with 3 columns of EPS. I was glad to see that you tried to seek explanation from BSE and Bloomberg. Now Bloomberg column A and C are different but there was no good explanation give. Whatever explanation given does not make sense to me. When Bloomberg is reporting current period EPS than there may be data waiting to come in but for all the past EPS data is already in and there is no updating going on. Then why is there difference at this time between May 2011 and June 2011 for prior year data. By May 2011 all data for previous year should be in and there is no updating going on.
Second, I believe you are a company with full fledge research team of yours. You have analyzed all BSE 30 company then why don’t you have your own EPS projection. It was very surprising that you are getting Bloomberg numbers and not even mentioning your projections.
Third, in reference to May Honest Truth it was very shocking to read your writing “Based on the earnings estimates made by the army of sell side analysts employed by the herd of brokerage houses, I applied an average PER multiple to these estimates - the price that foreign investors would likely pay for earnings - and arrived at the "forecasts" for the BSE-30 Index widely seen as a proxy for the stock market”. This is bothering me same as second item.
You do not rely on your numbers and use somebody else forecast. Especially when your reader including me come to you believing you are smarter than the rest. And when expectation goes wrong you sound to blame other analyst

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Jonathan

Jun 21, 2011

You have very smartly glorified yourself by comparing your case with that of Meredith Whitney.

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Sunil Doshi

Jun 21, 2011

Well Said Ajit ji. I am enlightened and satisfied. I am fully convinced that it is "Honest Truth".

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SYJ

Jun 20, 2011

Hi Ajit,
I had written immediately after you predicted the numbers that you should refrain from doing so. It was the first time you predicted the numbers and timing and it has flopped. I think EM provides lot of value to the subscribers and general investors without predicting the numbers. So, please stick to your strengths and don't be a number crunching analyst.

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Girish Jain

Jun 20, 2011

I have been reading your articles for quite some time now and am very happy to see this article. In fact, I am very impressed that you own up the thoughts you put forward earlier and shared the premise for the same and then worked on the critics received from readers. To be honest, this is the first time your promoted brand "equitymaster" has gained some positive attention in my mind (otherwise its mostly thought of as just another financial services company which sends me everyday a new email with some fancy promises of unrealistic gains and capital protection, which are done merely to get subscribers). I truly appreciate this article and as always your efforts for "fair" practices in financial sector.

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lala susanta

Jun 20, 2011

I think you wanted public attention and that is why you tried to predict the sensex. You may adopt any method to predict the market, you can never be accurate. If at all you are right, that may be by luck. No calculation in this world can predict an exact figure for Sensex at a certain time.
And certainly you are not GOD so that you predict some thing with 100% accuracy. As an investor and a researcher you should not predict the market. Your job should be to find long term investment opportunities.

In the above article you have blamed bloomberg and others for giving different numbers for Sensex EPS. At the first place you have committed a great blunder by trying to predict the Index and in the second instead of accepting your mistake you have put the blame on others. This is really very very bad. This shows how honest you are???????? Plz be honest to post my comments in the public domain.

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Kumar

Jun 20, 2011

I agree with Vaidya's comment above. How can the figures from Bloomberg for 2008 vary so much in just one month of 2011?

However, his comment regarding 'Consolidated' is wrong. There is NEVER a 'Consolidated' company. You can only own shares in the standalone company. The fact that that company owns shares beyond the specified limit in another company (say a 100% subsidiary) means that, legally, it is required to combine the accounts. But this is only for presentation. The other company continues to be an independent company.

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C K Vaidya

Jun 20, 2011

While each one is free to calculate and report EPS as they deem fit, I don't understand why standalone data should be used by anyone. As a shareholder, do I own standalone company or consolidated one? If I own shares in consolidated company, why should I worry about standalone results? Standalone results have the same meaning and importance as a division of the company.

What is surprising is the difference in Bloomberg numbers shown in the 2 columns for past years, particularly for For 2008 and 2010, the EPS numbers are 824 and 964, 912 and 991. I don't believe that lot of new data could have flown into Bloomberg between May and June 2011 for these past years. There is clearly something that is not explained by your analysis.

In the interest of investor education, please try to get to the bottom of these discrepancies in Bloomberg reports.

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Nilesh O. Thakkar

Jun 20, 2011

This is in continuation of my comment to the June-2010 article. Commodities have been financialised/ monetised in a unprecedented manner and this has weaken the fundamentals. But, fundamentals will become more and more dominant as we increase the time horizone and conversely, as we shorten the time horizone, other factors like behavioural biases will become dominant. Psychologically, as the index approaches the historic highs, the skepticism/ disbelief will take hold of the investor mindset and greed/ caution prevails over hope. This may prevent index to cross its previous highs in a decisive manner for a longer time. This is like nervous nineties in cricket. Ultimately, this may lead to crossing old highs with the PE multiple which is lower than the long term average, say PE of 15 with EPS of 1400. Even in the past, we crossed the 6 K mark with around 15 PE in 2005. Later on, there will be left out feeling, euphoria, and ultimately, crash and disbelief once again.

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Chandra N S

Jun 20, 2011

Dear Ajit, I was very vocal in my response over the previous article about differences in EPS/PER Data published by Bloomberg & BSE being stark in their appearance.

Thank you for clarifying what Bloomberg does and what BSE does, in identifying PE and EPS for Sensex.

Your advice has been very very sensible - "let it be whatever measure from data provider, take one and apply the same consistently". Thanks much for the recommendation, again! It is the consistency that helps make wealth.

On a separate note, I think it may not be a good idea to have both Bloomberg and BSE work together, or produce a unified reporting structure out of cooperation/coordination. Similar to the choice an investor has in selecting mutual fund schemes (though they can be index funds tracking same BSE Sensex from various fund houses), it would be good to see an investor having a spectrum of choices to pick from - in the way EPS / PE are calculated over widely followed indexes.

I personally decided to consistently follow BSE data. This is because BSE operational style is leading to a host of conservative factors (in not looking at consolidated earnings, or in not providing 'Estimates' dependent on XOs), and also is dependent on the 'Discipline' with which companies disclose their financial results. It automatically helps me internally build a suitable margin of safety in my investment model.

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