Consistent earnings growth is one of the major factors affecting an investor's decision to buy a stock. It also affects stock price movement. If earning growth takes a hit, then chances are the stock price will fall.
Net FY20 earnings estimates for BSE100 improved QoQ from -29 percent to -23 percent, led by net upgrades in materials, industrials, and utilities sector companies.
However, there are as many as 23 companies that have seen consistent downward FY20 earnings revision in the past four quarters. They include Pidilite Industries, HDFC Bank, Grasim, Lupin, MRF, PNB, Cadila, Petronet LNG, and TVS Motor, among others, Elara Capital said in a note.
“The maximum EPS downgrades over the last four quarters have been in sectors like healthcare, auto, cement, and financials. The healthcare sector has been affected sharply in the last two quarters due to concerns about US FDA approvals and drug pricing issues,” Jayant Manglik, President - Retail Distribution, Religare Securities Ltd told Moneycontrol.
Elara also downgraded Nifty EPS for FY20 to Rs 612 (down 2.5 percent) and FY21 to Rs 735 (down 1.4 percent) compared to the last quarter's (Q3FY19) estimate, primarily led by energy, materials, and telecom.
Yes Bank, Vedanta, Tata Motors and Eicher Motors are among Nifty stocks that have seen the sharpest downward EPS revision.
Now, the question is should you sell these 23 stocks if you have them? The answer is not simple, because it can’t be generalised. The slowdown in earnings or stock price could be due to fundamental or industry-specific issues, and each requires a different treatment.
“A strategy cannot be generalised for all stocks, hence when looked at particular sectors, investors with auto companies should hold their shares since these stocks are already beaten down. Profit booking in these auto players will not be beneficial now,” Umesh Mehta, Head of Research, SAMCO Securities told Moneycontrol.
“Certain blue-chip auto companies in the passenger vehicle and two-wheeler space was affected mainly due to the need for electric vehicles, subdued demand and over-supply. Month-on-month auto sales have suffered and hence the earnings downgrade is justified,” he said.
In the auto space, Jayant Manglik likes Maruti Suzuki, Eicher Motors, Bajaj Auto, Hero Motocorp and TVS Motor that are now attractively valued after the recent correction and hence, can be considered for investment.
“Coming to financials, we feel HDFC Bank remains one of the preferred investment picks on every dip despite premium valuations, considering its excellent track record of growth and superior asset quality and hence minor EPS downgrade should not be a worrisome factor,” he said.
Factors to consider apart from EPS downgrades
Earnings downgrades by analysts often reflect the lowering of confidence in the company from a short or a long-term perspective. But, that does not change the fundamentals of the company.
Before pressing the panic button, investors should closely look at the reasons as well as the frequency of these downgrades before booking profits or reducing holdings in the stocks, suggest experts.
Explaining the rationale, Manglik said that a stock like Pidilite is facing temporary growth slowdown and has been witnessing margin pressure due to higher commodity/input cost.
“Given the fact that Pidilite is the dominant player in the adhesive industry, its long-term prospects are bright and can be accumulated. Moreover, several sectors (such as cement, consumer staples) are expected to do well in case of demand revival led by macro indicators (monsoon, budgetary announcements, etc.),” he said.
Downgrades resulting from industry-specific issues or slowdown concerns should be taken seriously, but marginal downgrades or some short-term company-specific issues should not be the reason to sell or reduce position in a stock.
“Whether the earning downgrade effect is discounted in the price is the fundamental question that one should address before initiating any short term buy or sell in these companies,” Romesh Tiwari, Head of Research, CapitalAim told Moneycontrol.
“For traders the time frame is small and so they should give importance to technical factors like moving averages and RSI, whereas, investors must check the fundamentals of the company as well as the industry. A price fall after earning downgrades may make a fundamentally good company an attractive investment opportunity,” he said.
Tiwari further added that investors must check the promoter holdings, debt-equity ratio, government policies for the sector and expansion plans before committing their capital to such companies.
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