Market blithely ignores poor earnings while marching bravely onward

The December quarter results season is coming to a close, and the impression one gets, from the stock market’s perspective, is that it hardly mattered.

True, the results, on an aggregate basis, were far better compared to the gloomy expectations most investors had until the end of last year. But at the same time, they haven’t been all that good to warrant the sharp rally in the markets. As Aditya Narain, head of research at Citigroup Global Markets India Private Limited put it in a recent note to clients, “Two-thirds through the 3QFY12 earnings season, earnings growth is flat and largely in line with expectations – neither justifying the top-down gloom leading into the results, nor supporting the market’s more recent boom.”

The rally, of course, has been driven by a flush of liquidity into global markets. But the markets have been swamped with funds to such an extent that even some poor results announcements have been conveniently ignored by the markets. Tata Steel Ltd, for instance, reported a surprise loss, on the back of a large inventory write-down, which was equally unexpected. Still, the company’s shares rose by over 5% post-results, on the belief that results in future quarters will look better, now that the company has written down its high-cost inventory. This is typical of arguments in liquidity-driven rallies. Similarly, Bharat Heavy Electricals Ltd (Bhel) negatively surprised investors by announcing large cancellations of orders and a drop in its order book position. Its shares fell heavily soon after the results, but have nearly recouped all of those losses.

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Despite a poor showing for most companies in the December quarter, markets have remained firm. Mint’s Mobis Philipose analyses the numbers and tells us what led the rally and why the results don’t dictate market sentiments.

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There is a sense one gets from the street that the December quarter results are backward looking, and should be ignored, because things are expected to get progressively better for the Indian economy. This view is driven by the expectation that the government will shake off its lethargy and start making progress with policy decisions this year. Besides, while a rise in oil prices hurt the economy last year, this year is expected to be different.

Even if things play out in this fashion, investors are playing with fire by ignoring company-specific problems. Even on an aggregate basis, there’s hardly anything to get excited about. Among the BSE 500 ex-oil, ex-banks companies that have already announced results, operating profit has dropped by 2.6% on an aggregate basis. This is worse compared to the 2.7% year-on-year growth in profit witnessed during the September quarter. Ignoring historical performance in favour of a more sanguine outlook may sound good while justifying a market rally; but investors should keep in mind that such a strategy carries an unfavourable risk-reward ratio.

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Also See | Turning a blind eye (PDF)

PDF by Naveen Kumar Saini/Mint