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Sowmya Sundar

PERIODIC earnings announcements may not tell the whole story but they definitely provide the jist of it. These numbers may lead to higher or lower expectations and affect the valuation of the stock.

At times the management may also resort to window-dressing to meet the forecasts. But does it mean that these numbers are irrelevant? What information can you glean from interim financial reports?

Periodic earnings announcements do serve a purpose as they reveal information that would give a fair idea of the progress of the company. Additional disclosures, such as segment reporting, presentation of consolidated results and the geographical break-up, give a lot of information that would otherwise not be available in public domain at such frequency.

Analyst presentations and conference call transcripts are also available on certain company Web sites. These are valuable sources of information and give insights into the companies' operations and prospects. They give you a feel of what is happening in a company and where is it heading in terms of business performance. Periodic financial disclosures also show how the company compared with its peers.

They indicate a company's market position and control within the industry in that particular period and also point to whether a company has the potential to make the best of the given business conditions.

The absence of such periodic disclosure leaves a gap in financial information. Worse, it could lead to selective disclosures, giving room for insider trading. Small investors would be left in the lurch due to non-availability of information. The market might witness wider swings due to speculation and selective disclosure.

Information provided in financial statements is useful if scrutinised properly. For instance, the previous eight quarters' earnings announcements would indicate the trend in margins and earnings growth. Sharp deviations may require further scrutiny to judge the sustainability.

Any one-off instances having an impact on the earnings should be eliminated. Also, one has to be aware of the external factors governing the business and their effect on the earnings performance in any period.

When making an investment decision, adequate discounting should be done for any risks associated with the business. This would be based on the investor's risk-taking ability. It might also pay to take an independent view of the stock without the market interest in a stock influencing your decision.

Any stock that commands a higher valuation than its earnings can support will be vulnerable to volatility.

Markets generally tend to overestimate the earnings growth potential of certain companies or get carried away by exceptional earnings announcements without looking at the ground realities.

Often, stocks zoom or slump after earnings announcements and trade at valuations that cannot be sustained by earnings growth. It is better to avoid a stock that commands high multiples when the business environment is uncertain. Also, avoid momentum investing in such stocks. A little bit of caution and reasoning could protect you from extreme downside risks.

But do remember that numbers are usually factored in the stock price and should not be taken fully at face value. Future performance would depend on a host of external factors. A fresh investment decision should be based on the general business environment and the scope for business growth.

At the company's whim

A HOST of discretionary items can skew a company's quarterly performance. Expenses such as restructuring charges and contingency provisions may vary from quarter to quarter, purely based on the discretion of the company. Changes in accounting practices can also camouflage the actual performance.

Treatment of certain expenses such as deferred revenue expenses, advertisement and promotional expenses, research and development expenses, depreciation charges and provisions in various quarters can present a misleading picture of the financials.

There are instances of one-time income being deducted from other expenses, boosting margins. Earnings smoothing could disrupt the picture. (Business Line, May 5, 2002). Reading between numbers and a look at the notes would bring such issues to light and present a clearer picture.

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