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How can quarterly reports aid stock buying

How can quarterly reports aid stock buying
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First Published: Tue, Aug 02 2011. 08 43 PM IST

Updated: Tue, Aug 02 2011. 08 43 PM IST
Turn on any business news channel and you will find constant updates on the net profit and sales numbers of companies. It’s results season again with companies declaring financial numbers for the quarter ending June. As on 1 August, 1,328 companies, out of the total 4,170, have come out with their financial results for the quarter just gone.
Given the uncertain macro environment, the results may bring positive as well as negative surprises. Undoubtedly, this will make the already tentative decision of stock buying more confusing.
But sifting through the quarterly results systematically can actually help you assess whether a particular stock is keeping up with changes in the macro environment and if its growth is on track. Here are some financial facts you should look for in the quarterly results.
Revenue & profit growth
Revenue: Revenue or sales of a company show how much money it generates by selling goods or services. An increase in the same over the earlier comparable period shows that the company has used its resources more efficiently and vice versa. “A growth in revenue would indicate that the company is moving in the right direction,” says Vinay Agrawal, executive director (equities broking), Angel Broking Ltd.
For many industries, however, quarterly revenue is only seasonal and annual growth is a better indicator. Also, read the company’s press release for details on whether the increase in revenue can be attributed to hike in product prices or increase in sales volume. Increase in sales volume is better.
Net profit: One of the most important figures, it is obtained by deducting operating expenditure from sales and then accounting for interest, depreciation and tax expenses. Net profit depicts the ability of a company to run a lucrative business. Here, too, compare quarterly and annual growth in profit.
For example, in the last quarter of FY11, Larsen and Toubro Ltd reported a sequential sales growth of 33.18% and an year-on-year (y-o-y) growth of 12.74%. Net profit on the other hand increased 17.25% y-o-y, showing that costs were curtailed resulting in higher profit growth compared with sales growth. Quarterly sales though could have higher on account of seasonality in revenues (the business environment in October-December period is different from January-March). Hence, the y-o-y growth number is a more accurate representation of revenue growth in similar conditions.
Operating profit margin
This essentially looks at the profit a company makes before accounting for charges such as interest, depreciation and tax. It is also called earnings before interest, taxes and depreciation, or Ebitda. It measures the profit from the core business keeping out other charges.
This ratio can be calculated by dividing the figure under operating profit by the figure under revenue. Alternatively, you can take out taxation, depreciation and interest charges from the profit after tax figure.
“It could be the case that growth is healthy but if margins have gone down, profitability in the long-term can be hurt,” says Agrawal. Operating profit margin varies depending on the industry of operation and the scale. Compare the figure with the previous year’s figure for the company and the current margin of its competitors to know whether the company’s margins are substantial.
Says Alex K. Mathews, head (research), Geojit BNP Paribas Financial Services Ltd, “Analysing revenues and costs is important. In this quarter, margins may be under pressure on account of high input costs and higher wage expense for many companies.”
For instance, the last quarter of FY11 was good for ACC Ltd in terms of sales growth at 14.1%. However, because of higher raw material, wage and utility costs, profit margin was lower at 23.11% compared with 29.6% in the previous year. This shows some cost pressure; as a result, net profit for the quarter declined to 13.45%.
Interest cover multiple
In the current high interest rate environment, a number of companies are finding it difficult to raise debt funds at a reasonable cost. Also, interest expense is eating into the profit margins for many companies.
Interest cover multiple is calculated by dividing a company’s earnings before interest and taxes (Ebit) of one period by the company’s interest expenses of the same period. This number is used to determine how easily a company can pay interest on outstanding debt. A low multiple indicates expenses related to debt are weighing down on the company’s finances.
Says Tarun Sisodia, head of research, Anand Rathi Financial Services Ltd, “High lending rates are affecting corporate profitability as it is difficult to find cheap money in the current macro environment.”
Say, for a company like DLF Ltd with increasing level of debt on the balance sheet, and a difficult time in terms of real estate sales, analysing the interest expense is important. If we look at numbers, the interest cover multiple has decreased from 3.59 in September 2009 to 1.74 in March 2011.
Return on equity
This is the net profit divided by the average shareholder’s equity. Return on equity (RoE) shows how much profit a company generates by using shareholders’ investment. This information is linked to the balance sheet of a company, which means most companies publish related numbers only in the full year financial results. What you can do is use the total equity detail from the last published balance sheet.
For the annual earnings figure, use the new quarterly profit and replace earnings of the same quarter in the previous year with this year. The change in the ratio will show the impact of the current quarter’s earnings on the RoE of the company.
RoE is useful for comparing the profitability of a company with others in the same industry or to assess the change in its profitability over time.
Says Mathews, “Recalculating RoE after one quarter is meaningful in the present situation as earnings are under pressure owing to macro factors. It is prudent to look at quarterly and biannual changes in RoE.”
What else should you look at
Don’t forget to read the footnotes in the statement. This section has some crucial bits of information. Compare these with footnotes in the annual balance sheets to ensure that all items mentioned are in line with what’s been said before.
Another important aspect is to assess the macro environment and industry situation. For example, keep in mind that in a high interest rate environment earnings in some industries, such as automobiles, real estate and banking, are under more pressure than others. You must also keep in mind factors such as quality of management, industry dynamics and the economic environment.
Illustration by Shyamal Banerjee/Mint
saurabh.k@livemint.com
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First Published: Tue, Aug 02 2011. 08 43 PM IST