TO BUY OR NOT
A company's quarterly financial statements typically contain the profit and loss account for the last quarter, the corresponding results in the previous year, the year-to-date financial performance on the profit and loss account, segment information in a prescribed format, investor grievances and comments on the actions taken by the management to address the auditors' qualifications in the immediately previous audited financial statements. According to analysts, all these information about the company's most recent financial performance acts as an important trend indicator on the company's earnings achievement.
However, a sound investment is generally made after understanding the business , the environment (including social and political) in which it operates and the consequent risks that can impact the attainment of the entity's corporate objectives. Explains Monish Chatrath, national markets leader, Grant Thornton India: "There could be problems too for those looking to buy and sell stocks based on fundamentals alone. While an analysis of the fundamentals can generally indicate whether a company's business holds promise and is on the right track, it is the timing of purchase of the stock, that's perhaps the more important factor in the markets today."
That's why you sometimes come across companies with perfectly good businesses languishing because of their failure to attract the ephemeral "market fancy." Analysts believe that there are no definite answers that can help investors to ascertain whether the company's business will deliver such return or whether the said company's operations are likely to remain technically sound in the future. "However, there are some financial ratios that help us get closer to the answers. The level and historical trends of these ratios can be used to draw inferences about a company's financial condition, its operations and attractiveness as an investment," feels Chatrath.
These ratios include return on capital employed (a measure of the efficiency with which a company uses its funds), return on equity (a measure of the returns generated on shareholder funds), inventory turnover ratio, debtors turnover ratio, current ratio, price-to-earnings (the most commonly used and perhaps abused valuation tool!), price-to-book value (illustrates how adequately or inadequately the share price of a company reflects the shareholders' share of assets in the business).
HOW TO TRACK
With stock markets witnessing high level of volatility, analysts feel that it's pertinent for you to track the results of India Inc., with particular emphasis on a company's fundamentals before taking any exposure. For the uninitiated, fundamentals are associated with the economic health of a company and are measured in terms of revenues, earnings, assets, liabilities, return on equity, return on assets, return on investment, growth prospects and cash flows. The fundamentals speak more about the story of a company. "The analysis of a company's fundamentals involves getting deep into its financials, rather than day-to-day movement in its share price. It is done in order to calculate the intrinsic value of a company's stock," says Chatrath.
So if a company's stock is trading above the intrinsic value or fair value, then the stock is overvalued, and if a company's stock is trading below the intrinsic value, then the stock is undervalued. Pankaj Pandey, senior research analyst at ICICI Securities, relates volatility in a stock to positive or negative surprises in the earnings of a company. "For stocks that are well researched, volatility may be lower if company delivers earnings around expectations. However, for stocks that are not well researched, lack of information pre and post results would fuel volatility," he elucidates.
Analysts caution that you should not make profound assumptions on the future of a company's performance on the basis of its quarterly results. They believe you should look at factors which are pointers to the company's fundamentals and financial ratios. Since looking at profit margins for a company is meaningless by itself, financial ratios facilitate comparison, across companies in a sector and for a company over a period of time. Thus, you should compare these factors with the company's competitors before drawing any inferences on the company's profitability.
"Future earnings are dependent on the decisions and alternate courses charted by the company for its future growth. Hence quarterly results is not the only parameter," reasons Pandey. According to him, quarterly results should be looked from the point of view of revisiting or reassessing earnings prospects and return expectations.
While financial ratios contribute towards making the right investment decision, analysts say that even they have limitations. Reason: Most financial ratios rely on historical financial data which may not capture subjective issues like management quality, business potential, investor friendliness and stock liquidity, which are all key components of an investment decision. These financial tools, analysts reckon, should only be used by investors to pick up the right stocks