What is more imp. than EPS grth?

Wed, 27 Apr Pre-Open

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The corporate results for the quarter ended March 2011 are flowing in full steam. Being the full year results for most companies the same hold sufficient importance. Especially if you are looking at comparing the companies' capex and capacity utilization for the fiscal with the projected ones. These are numbers that could impact profit growth going forward.

Investors who take their decisions based on quarterly EPS trends are looking for cues on the next quarter's profit growth as well. The rising interest rate scenario is expected to make leverage expensive. Further with high inflation there is limited headroom to raise product prices.

Thus some fixed costs (capex) can ensure higher saleable volumes. However, sustainability of the existing profit margins would depend upon whether the company can retain pricing power. Also whether the capex necessitates a strain on cash flows. But factors like inflation and interest rates tend to be cyclical. They impact a company's profits only for a temporary period. And their impact could be judged by studying profit trends for companies and sectors over a long term.

But the exceptional profits are the cases which investors need to be most careful about. It is most likely that the exceptional gains may not even be recorded so in the books. Resultantly investors may misconceive them to be sustainable in the future.

Derivative gains, profit from sale of land or sale of products that are temporary in nature could bring in spurts of profit growth. They could also camouflage heavy losses that the core business may be incurring. And as a result, investors may end up valuing the wrong EPS (earnings per share).

The recent instance of the RBI penalising banks for vending complex derivatives is a case in point. As long as the banks helped companies boost their near term profits they were happy to participate in the wrong doing. However, once the trends reversed, companies that fell in the derivative trap paid heavily for the same. The banks themselves had to rid their other income portfolio from derivative related incomes. These had at one point of time made the other incomes swell for most banks.

Thus we always advise investors to look for sustainable profitability rather than the next quarter's numbers. By doing that you would be forced to ignore items that may cease to impact profitability over the next few quarters. Also it will help you pay a more rational price for your investment.