Errors in earnings estimates give profit-making opportunity

The results season is about to begin. Brokerages are releasing 2013-14 first quarter estimates. Business Standard collated some consensus estimates on Monday (Profit boom amidst sales gloom). The averaged estimates of seven brokerages suggest a fall of 0.4 per cent in combined sales for the Nifty 50 (excluding Coal India), along with a rise of 11.8 per cent in net profits. Ebitda margins are expected to decline.

There are always big errors in earnings estimates though averaging may reduce errors a bit. Let's assume the analysts have successfully identified key trends. This means the slowdown continues. If sales drop, it would be the worst quarter in several years.

The profit growth will come from a few broad trends and very few outperformers. One set of 11 companies – pharma, IT and private banks – will generate a little over 20 per cent growth in respective net profits. Another set of seven – FMCG, automobiles, and conglomerate, Reliance Industries, will grow profits between 10 and 20 per cent. Five companies will see profits growing by less than 10 per cent and 26 companies are expected to see lower profits, or losses.

Given the predictions, one can make some deductions. One, the falling rupee will boost IT and pharma performances. Two, the falling yen reduces Maruti's costs. Three, given lower Ebitda margins, and lower sales, domestic players can earn higher net profits only if interest outgo reduces. Four, earnings gains mean more in real terms, since inflation was down in April and May at least.

Lower interest outgo implies RBI’s policy rate cuts over the past 12 months are having a concrete positive impact. Private banks doing well could also be partially explained by falling interest rates. Since banks have not cut rates in tandem with RBI, their net interest margins have expanded.

On the flip side, real estate firms, PSU oil marketers and metal businesses are all expected to do badly. Metals have been hit by the global slowdown, real estate must contend with flat demand, and PSU refiner-marketers are struggling to cope with the weak rupee.

Note that all these trends, good or bad, are beyond the control of individual businesses. The consensus estimates don't really single out any companies for its management skill, or smart business model. Nor is there the suggestion of a serious turnaround in sentiment.

There has been extraordinary volatility in the recent past and this is likely to continue. In addition, there are bound to be some big errors in the estimates. This could mean a wild ride through the results season.

The Nifty set is available in the stock futures segment. So, the trader can go both long or short whenever an error pops up and there's an opportunity for big profits.
The author is a technical and equity analyst