Earnings upgrades vs share price moves can help spot good buys

Stocks such as Hero Motorcorp, RIL and ICICI Bank have seen earnings upgrades since June 2012 but their scrips have under-performed

Usually, stock prices are leading indicators of any changes to earnings estimates of individual companies. Which means, stock prices start factoring in any upward or downward change in earnings estimates of any company slightly ahead of the actual change in earnings numbers. Recent data reveals that some stocks have witnessed a divergent trend to this theory. Stocks such as Hero Motorcorp, Titan, Reliance Industries, Dabur, ICICI Bank, Bank of Baroda, Larsen and Toubro, Wipro, TCS,Infosys have witnessed earnings upgrades since June 2012 but their scrips have under-performed compared to MSCI.

The key reasons behind this could be some major concerns around them or a mere case of over pessimism. In case markets have overlooked the positives in these stocks, they make good cases for value buys, believe analysts. Leading brokerage Morgan Stanley has in its report dated 22nd November 2012 highlighted few of such value buys. "We can argue that earnings will catch up with share prices, but the opposite cannot be ruled out. Either way, these represent potential opportunities for investors. Our top buy trades include ICICI Bank, L&T, Infosys and Dr. Reddy's".

Technology has witnessed improving estimates, but share prices have yet to respond. This could be as large part of the revisions have been driven by a weak currency and overall demand environment continues to be weak in this sector. However, slowdown is more company-specific in this sector depending on the company's competitive strategy.

In complete contrast, most fast-moving consumer durables (FMCG) scrips have witnessed earnings upgrades-led by strong stock performance for the third quarter in a row. However, recent weeks have seen FMCG stocks under pressure due to reallocation of money in favour of cyclical sectors.

In the case of financials, private sector players have witnessed earnings upgrades while PSU banks have seen downgrades due to worsening asset quality, a factor well reflected in their stock prices. Going forward, most analysts believe markets will increasingly look at earnings growth of India Inc.

“We believe that earnings and quality balance sheets will become the key factors for markets, more than ever before. We expect companies and sectors—particularly with a shrinking investible universe—seen displaying sustainable earnings momentum will see valuations continue to expand, in many cases, beyond recent historical highs. The premium for earnings predictability will only get richer, in our view”, believe Abhay Laijawala and Abhishek Saraf of Deutsche Bank. While earnings upsides are significant for any company, one should also look at the key macro-economic headwinds it faces while picking a stock.