Eye On The Market: Don't read too much into Street estimates ::Business Line

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During the earnings season, stock market gyrations can become even more bewildering to normal investors than they usually are.

The stock of a company turning in good profit growth may be battered because it disappointed the all-powerful ‘street'. Another may be eagerly bid up after insipid numbers, because the company did better than the street expected.

Thus we had the case of the Hindustan Unilever stock plummeting 3.5 per cent after it announced profit growth of 33 per cent last week. Or Tata Steel rising by nearly 5 per cent after the company declared its first loss in many quarters.

WHAT ‘STREET'?

Media and market commentators glibly explain all this price action in terms of companies matching or falling short of ‘market' or ‘street' estimates. But investors need to take the estimates being cited with a teaspoonful of salt.

To begin with, you should examine what exactly the street estimate is made up of. Theoretically, it is supposed to be the consensus of profit projections for a company from all the analysts in the market who track it. By this yardstick, the street estimate used by a television channel should be no different from that cited by a broker.

Yet, in practice, one often finds different street estimates being bandied about for the same firm. This is because the term ‘street estimate' may loosely be used for numbers derived from polling a random set of analysts.

Now, what five or six analysts have to say about a company's performance should not be taken as a proxy for what the entire market expects. Nor should hits or misses relative to such an estimate influence investment decisions.

WHAT'S THE METHOD?

Then, there is the question of how robust the ‘consensus' estimate is. First, there is the number of projections which are averaged out to arrive at the consensus.

It may be all right for investors to measure a company's performance against the average of estimates put out by 40-50 analysts. But the exercise would be highly misleading if the average is from just 2-3 analysts.

Now it may be possible to compile profit projections from 40-50 analysts for Sensex or Nifty companies, but not for small or mid-cap names.

Given that much of equity research in India is restricted to just the top 200 stocks, consensus estimates obviously don't have much meaning for a good part of the listed universe.

WHAT CONSENSUS?

A consensus estimate may also have little meaning in cases where analysts differ widely in their opinion of where the business is headed. Such instances are quite common among commodity companies and companies with a global leg to their operations.

Consider index heavyweight Tata Steel. Bloomberg shows the company to be tracked by 55 analysts who have a median estimate of Rs 46.1 for its per share earnings in 2011-12.

But this average masks a wide divergence. While the most bearish analyst in this set expects Tata Steel to report per share earnings of no more than Rs 9, the most bullish one expects it to deliver Rs 92, ten times as much!

WITH THE TIDE

A final fact that investors need to keep in mind while reacting to hits or misses is that analysts are not infallible. After all, analysts have no crystal ball to help them foresee a Greece default that may freeze up all global liquidity. Or even predict a Supreme Court decision that terminates a company's licence to do business. In most cases, therefore, analyst estimates of future profits for a company are linear extrapolations of performance in the recent past, with a few tweaks here and there.

This is why there is a certain herd effect to street estimates. While the going is good and corporate India is on a firm wicket, rosy projections are the norm. When a slowdown is in place, the same estimates are mercilessly whittled down.

It is the rare analyst who can accurately call the turning points in corporate fortunes, whether they come from the business, sector or the economy as a whole.

From a regulatory angle, maybe it is time to insist on a disclaimer every time a market participant or commentator puts out a ‘street estimate'. If you are a long-term investor, you need not lose sleep every time your company misses street estimates by a whisker. It may not matter as much as you think.