The Hindu Business Line : Understanding the results announcements

Listed companies come out with their earnings scorecard once every three months. These results not only provide the performance in the respective period but could also shed light on what is likely to happen in the short term. With the market rewarding companies that meet expectations and penalising ones that falter, deciphering earnings announcements becomes increasingly important in an investing decision.

Revenue

Revenue is the amount of money that an entity receives for goods sold or services rendered. Revenue growth could either be volume driven, realisations-driven or `other income'-driven (non-core). In the core business, revenue growth can either be driven by increase in production/volumes or improvement in realisations/billing rates.While a 30 per cent revenue growth is impressive, investors need to look at the quality of growth too. The non-core other income can also bolster revenue growth. Take for instance Kirloskar Brothers September 2006 results. The company declared a 95 per cent surge in revenues; a substantial part of it, however, was income from the sale of investments in its subsidiary. This revenue growth is unsustainable, as Kirloskar Brothers does not have another 51 per cent of Kirloskar Copeland to divest.

Operating margin

Operating margins, a measure of profitability, is operating income divided by revenue. In other words, it is the percentage of revenue that the entity can keep for itself after meeting production, selling and administrative costs. Operating margin growth, which is measured in terms of basis points, could increase as a result of higher realisations or drop in costs. While better operating margins suggest that the company is on a strong wicket. At the same time, high operating margin call for attention, especially when valuing stocks on the price-earnings parameter. SAIL, for instance, reported operating margins of about 43 per cent for the March 2005 quarter. A subsequent drop in steel prices eroded its operating margins, which is now about 30 per cent.

Earnings

Earnings is the amount that the entity has earned for its shareholders (including preference) after considering all costs and charges, including depreciation, interest and taxes. While earnings growth is a key parameter, the underlying factor is per-share earnings (Post tax earnings divided by number of equity shares outstanding). Though Basant Agro reported an 18 per cent earnings growth for the September 2006 quarter, a substantial expansion in equity resulted in a 52 per cent fall in earnings per share. While revenue and operating earnings are easy to evaluate, depreciation and notes are most often ignored. These items, however, have their importance.

Depreciation

Depreciation, a non-cash item, is an accounting charge for erosion in the value of a tangible asset due to wear and tear, age, or obsolescence. Although this item rarely reveals the company's performance over a three-month period, a sporadic change in depreciation, however, throws light on fixed assets.

Let us take CCL Products' December 2005 results. The company reported a charge of Rs 1.3 crore as deprecation against Rs 0.6 crore during the September 2005 quarter. This suggests that its fixed assets have more than doubled, indicatingfurther that additional capacities could be ready for use.

Spotting such surges in depreciation charges could be of immense value when capacity is a key growth constraint. Investors who ignored this surge in deprecation would have had to wait until September 2006, about an eight-month lag, to find that capacity addition had indeed been the revenue growth driver in the fourth quarter of FY-06 and the first quarter of FY-07.

Footnotes

One can only afford to overlook notes to accounts at one's own peril. These notes provide qualitative information with which the quantitative information can be interpreted. These notes, though not a mine of information, provide critical inputs with which financial data are to be adjusted for.

With companies off late increasingly resorting to growth through mergers and acquisitions, notes are the key to evaluating the company's performance.

Take the case of Sterlite Optical Technologies' second quarter results for FY-07; the company reported a two-fold rise in revenues and a huge 16-fold rise in earnings. Going overboard over such a performance, however, would be irrational. The trick to analysing the company's performance lies in the fineprint.

The fourth item of the notes indicates that the results of the September 2006 results are not comparable with that of the previous periods; the third states that the results include the performance of the power transmission business, which the company bought during the quarter.

These two items highlight the case that Sterlite Optical Technologies' improved scorecard is unlikely to be sustainable.

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