The Hindu Business Line : How stock prices react to results

The way stock markets react to the unveiling of company results can be puzzling to the casual observer. Jaiprakash Associates announced an over three-fold increase in its net profits for the latest September quarter, but the stock, which was trading at Rs 255 just before the results, was beaten down to Rs 210 by Friday.

Yet, Bharat Petroleum’s announcement that it made a loss for the latest September quarter saw the stock move up from Rs 505 to Rs 509 after the announcement.

Why are investors unhappy with a trebling of profits from one company, but yet very content with losses from another? While these kinds of stock price moves may make you wonder if stock markets are indeed rational (leave alone efficient), there is a method to all this madness.

Invisible expectations

To start with, when stock prices react to a company’s numbers, they are measuring them against an invisible benchmark expectation. Most of us know that each stock price carries an implicit PE multiple or valuation – what investors think they ought to pay for that particular business, based on its prospects.

A stock trading at a PE of 30 times factors in a much higher growth rate from the business than one which trades at 6 times. Therefore, if the company with a 30 PE delivers a tepid 15 per cent profit growth, investors are unlikely to be satisfied with that. On the other hand, a stock trading at a single-digit PE may merely need to report flat profits for the stock price to hold up.

Valuations apart, every large company reporting results is also measured against the now omnipresent “street” estimate. Today, most large Indian companies are being tracked by a veritable army of analysts.

Forecasts and estimates for quarterly sales and profits for most companies are available well ahead of the results season. Stock prices tend to factor in these estimates in the run-up to the results.

If the company’s numbers stray substantially from this “street estimate”, prices duly react to factor in this new information.

If they are much better, the stock price may soar; if they disappoint, the price drops. If the Bharat Petroleum stock managed to rise despite reporting losses, it was because the company managed to narrow its losses for the quarter, much more than the markets expected.

Against net losses of Rs 2625 crore in the September quarter last year, it curtailed losses to Rs 158 crore this year. Doesn’t that put the numbers in better light?

The future matters

The markets are also eternally on the hunt for new information that may have a bearing on a company’s future. (A company’s results, after all, are a piece of history).

If any such information trickles into the markets along with the results, it is likely that the results will be promptly ignored and the new data lapped up.

The stock of technology major Infosys has been known to behave quite strangely on the days it unveils its results. The stock may dip sharply despite reasonable-looking numbers and rise despite sobering results.

This happens because earnings announcements from the technology major are often accompanied by a guidance on how revenues and profits may pan out for the year ahead.

If the guidance shows the management striking a cautious note, the stock’s valuations may be marked down. If it is quite cheerful, the reverse happens. After all, once you have an “outlook” on how a company may fare in the year ahead, information about the past three months appears less than useful.

Management announcements

Even if a company doesn’t issue a guidance, the management comments or announcements that accompany the results can sometimes have a greater impact on stock prices, than the results themselves. Bharti Airtel’s stock plunged to a new 52-week low on Friday after the company unveiled its results.

That the company managed a 13 per cent year-on-year growth in its net profits for the September quarter was not bad news in itself. What the market was reacting to was the tepid growth in the company’s sequential numbers and another development.

Bharti’s move to join the mobile tariff war, by introducing “per second” billing, gave rise to new investor concerns that falling realisations would make it difficult for the company to deliver growth over the next few quarters.

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