Looking ahead

Sowmya Kamath | Print Edition: November 2012

Predicting the future is difficult. It is also the key to success in the stock market. To help investors make decisions, many companies, while announcing their results, talk about how they expect to perform in a given period.

Though it's an important indicator of where the company is headed, it cannot be the sole basis of investing, say experts. While big technology companies such as Infosys and Wipro give earnings guidance, some like Larsen & Toubro give revenue estimates.

Some auto companies guide for sales while pharmaceutical companies give guidance on revenue growth. Banks provide estimates of credit growth.

The guidance given by a company can impact its stock price. For example, on July 12, the Infosys stock fell 10% to Rs 2,251 after the company disappointed by saying its dollar revenue would be $7,553-7,692 million, representing full-year growth of 8-10%, as against the market expectation of 12-14%.

The reason guidance is taken seriously is that the people running the business are the best judge of its performance.

"Company guidance gives a broad sense of how its financial performance may look like at the end of the year. A certain set of companies gives guidance within a narrow range while some give just a broad direction," says Pankaj Pandey, head of research, ICICIDirect.com.

Investment tip:Best stocks that hit one-year lowsKaushik Dani, head of equity at Peerless Funds Management, agrees. "Company guidance is based on proper understanding of the business. People who run the company are the closest to the business realities and in a position to predict its near-term future. Though it does not mean the company will perform in line with the guidance given, it gives a fair idea about what can be expected from the company and the sector in which it operates."

But there is always a reliability question. "In the current downturn and uncertainty, both domestically and globally, it has become difficult to give an accurate guidance. Companies such as Infosys with an impeccable record of beating estimates have also been unable to meet their guidance in the past few quarters. Consequently, many companies have stopped giving even indicative guidance," says ICICIDirect.com's Pandey. There's another point. Can you blindly follow what companies say, given that so many of them have been under the lens over issues related to corporate governance?

"From an analyst's point of view, guidance by companies is an additional data point. Projections are based on information from companies, monthly data and interaction with dealers or user industries.

As far as guidance is concerned, some weight is given to the past of companies as they have the pulse of their business and are familiar with the ground reality," says Rikesh Parikh, vice president, markets and strategy, Motilal Oswal Securities.

Earnings guidance can be an additional data point for investors and analysts, but there are some worries. "There is a concern that guidance is based on the management's understanding at a particular point of time and in this dynamic world things can change quickly. There is also pressure on the company to meet the guidance irrespective of the ground situation. Thus, before investing, it's important to look at the assumptions behind the guidance," says Dani of Peerless.

Here are some factors one must take note of before investing on the basis of the management's guidance: Track Record: The past record of meeting targets will give a fair picture on how reliable the company's estimates are.

Industry comparison: Since guidance has an immediate impact on the stock price, there's a chance the company will either give conservative or over-the-top guidance. So, it is important to know what other companies in the sector are expecting.

"Weighing a company's guidance against own understanding and overall situation in the sector and the economy gives us a sense of how reliable it is," says Pandey. Continuous Monitoring: Companies may have a conservative or an optimistic approach towards economic environment. So, it is important to monitor developments in companies.

"Some prefer conservative guidance, purely because of their style or if they are in a business which is volatile in nature. This lowers chances of disappointment. Companies which do not foresee macro changes in the business environment and are optimistic about their prospects may give an aggressive guidance. But in such a case, any small change will lead to a downgrade of guidance. One has to look at assumptions made at both micro and macro levels.

This will help you know whether the guidance is ambitious or not," says Dani. For example, if a company has given a conservative guidance and has been able to bag a lot of new orders, it may upgrade its estimates.

While there is no particular sector which may give inaccurate guidance, companies more exposed to currency volatility, regulatory environment and political uncertainty give a less reliable guidance.

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