Make sense of the reams of numbers that companies publish every quarter to sharpen your stock-picking skills
WHEN it comes to investing in the stock market, investors emulate other investors who, in turn, copy other investors and so the cycle continues.
John Maynard Keynes, the most famous economist of the twentieth century, equated this phenomenon to what average opinion expects average opinion to be.
Keynes, an avid stock market investor himself, compared stock market investors to the readers who participated in newspaper beauty contests, which were extremely popular during the time Keynes lived (essentially first half of the 20th century). Such contests required readers to pick up who, they thought, were the five prettiest women from a long list. The choices made were aggregated and the five prettiest women were picked up from the lot. Those readers whose list matched with the five prettiest women were rewarded by the newspaper. So, for the readers, to be anywhere close to win the prize, their choice was not on what they thought were the prettiest women, but on the women other readers were also likely to vote for.
As Keynes wrote, It is not a case of choosing those [faces] that, to the best of one's judgement, are really the prettiest, nor even those that the average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.
Keynes died way back in 1946. Sixty-four years hence, things haven't changed much. Stock market investors continue investing on the basis of a recommendation from a friend, a broker, a relative or even a television anchor for that matter, and keep trying to figure out "what the average opinion expects average opinion to be".
Moral of the story: "We are like this only". Investors do not use their own brain while deciding which stock to invest in or for that matter whether they should sell or continue to hold onto a particular stock.
All this despite the fact that there is a lot more information available on companies now than there ever was. One way to gather information about the company is by looking at company results which are announced at the end of every three months. Listed companies are mandated to disclose their financial results within 45 days of the end of a quarter.
So, by now most corporates have declared results for the second quarter (July-September, 2010). This gives investors an idea of how companies are performing, and also helps them to take a call on whether it's worth investing in a stock or to continue holding it. Investors can access the results on the websites of the Bombay Stock Exchange and the National Stock Exchange. Several companies also post financial results on their websites.
Half-yearly numbers are an important tool for analysts as they give them a sense as to where the company is headed in the next 3-4 quarters. But that is as far analysts go. What should you, as an investor, look out for in these financial numbers?
Basics First:
Investors should start by looking at sales and profit growth. If sales are sluggish, then you need to look deeper and analyse. Similarly, if profit margins (profit expressed as a percentage of sales) are under pressure, then you need to find out why is that happening? One simple way of doing this is to compare the results of the first six months of the current year, with the first six months of the previous year. Also, you need to look beyond numbers. Take the case of ACC. For the three months ended September 30, 2010, sales were down 15% at 1,759 crore. Profit after tax fell 79% to 86.31 crore. According to a statement from the company, the volume of clinker production and cement came down due to the shutdown at Wadi II for hook up and commissioning. So, the company did not do well because a major plant had to be shut down. But that does not mean that cement, as a sector of investment, is on its way out. Cement, as a sector, had a bad quarter. However, the worst is over and the sector could see better days ahead. Increased focus on infrastructure and a good monsoon could help the sector grow in the coming years.
Take the case of companies in the FMCG and the consumer durables space. You can look at what has been the response to new product launches. In case of IT companies, it makes sense to look at whether the company has been adding new clients.
Look at the Big Picture:
To get a complete lowdown on where a sector is headed, at times, it may be useful to take a look at the leading company in the sector. Take the case of State Bank of India. Its profit for the period from June to September, 2010, went up 0.5% to 2,501 crore. Now that, to some extent, tells you that banking, as a sector, is headed for trouble as interest rates go up.
The SBI result indicates that profitability will be under pressure in the coming days. The days of low-cost deposits are over. Similarly, if you look at the results of Hero Honda, profit after tax fell 15% to 505.6 crore. Raw material prices, especially that of steel, have started moving up, which will have an impact on profit margins.
The other learning from this example is that a company's input costs play a major role in determining which way profits are headed. So, if steel prices go up, margins of automobile companies could take a hit. Rubber prices are on an upside. This will affect tyre companies. Similarly, if the price of crude oil goes up, it will affect airlines adversely and higher prices of agri commodities impact FMCG companies.
Beyond The Good & The Bad:
Take the case of Ester Industries, which manufactures polyester films. Profit after tax increased 535% from 5.8 crore to 36.7 crore in September 2010. According to a company release, A few thin polyester film plants were converted to produce industrial products like LCD screens and back panels of solar PV cells. This led to a huge demand for polyester film which, in turn, led to an increase in prices globally. As a result, Ester Industries was a beneficiary. In such cases, investors need to understand whether this demand is likely to sustain for the next few quarters and accordingly take a call. "Many a times the stock price will go up in anticipation of the results and investors need to take that into account.
On the other side, you have stocks like Mahindra Holidays and Resorts, that reported lower profits numbers for June and September 2010, compared with the previous year. The company is going for a higher upfront fees from members, and reducing freebies, which is an excellent move from investors' perspective, Clearly, this seems to be a short-term initiative which will benefit the company in the long run.
So, keeping pace with quarterly results will go a long way in helping you spot future winners.
A READY RECKONER
Here's what you should do when looking up financial results:
1 Compare like to like. For example, if a strike affected a company's output last year, it is safe to assume that this year's quarterly numbers will be good
2 Get sector-savvy. Look at how different companies in a particular sector operate and how they cope with the different factors affecting the industry
3 Watch out for pledges. Promoters have to disclose pledged shares with quarterly results. Try to find out why the promoter has pledged shares
4 Look for analyst insight: Some companies put analyst presentations on their websites. They can offer a useful insight on the company's outlook
5 Think before you act: Don't jump to a conclusion if one quarterly result is bad. Take a closer look before forming an opinion
