September 23, 2006

Research Reports - The Fun of reading it

I enjoy reading research reports. There have been instances in the past when research analysts post reviews that are opposite in nature for the same event. An example of this was with SBI when the results were posted for the third quarter. Two research agencies, extremely reputed gave exactly the same reasons, but had a final outcome that was diametrically opposite.

Here is another instance of another research company. As an amateur analyst myself, I know how difficult it is to estimate the cash flows for a company. The company in this case is OMAX Auto. There was a recent 'buy' order from this reputed research agency. I went on reading it and I found the section of financials interesting. The company had given an expectation of the following in the previous year.

Consider the same the next year in the following. The research predicted that the company would have a sales figure of Rs 662 crores while the actual sales for the company was only Rs 578 crores. This increase is only 9% when the projected rate was approximately 25%.
The reasons that were cited were as follows.
  • Employee cost : This amounts to close to 5 crores
  • Power cost : This contributes to 5% of the cost. It was about 17 crores last year and this year it is at 24 crores. Of this 10% was the natural growth of sales. Hence it was already incorporated in the financials. The increase was only 5 crores.
  • Interest cost : This is a reason that is unacceptable as the capex plans was already given in the previous year and their model should have incorporated this high cost.
  • The company has saved 2% of sales which amounts to 11.76 crores
If one adds all these that the company has mentioned, they should have still got the profit that they had predicted as the cost of savings from raw materials has been offset with the increased cost in salary and power. Yet, they missed the mark by a big margin. Why cheat the investor for something that the company is not able to deliver? The research report completely ignored the poor sales forecast that it did and blamed the entire game onto the management for ineffective performance. Now, this is unfair. How is the company at fault when your forecast was way off-mark.

The answer lies somewhere in an article that I read recently by Paragh Parekh. He was in our institute to give a guest lecture and I truly enjoyed the subject on "behavioral Finance" that he taught that day. However, coming to this issue, he mentioned that the research agencies have targets on the number of reports that they need to generate in a year! I was stumped to see it and now after reading this, I find it believable. I have no solutions to this issue. But then, I think the research house should
  • show the research agency's previous call on this company
  • give reasons for a downgrade for this company
  • the number of times it has downgraded on the whole for all companies that it normally researches
  • the frequency of such changes and the timing of such changes
Now, as a research agency, I can still escape by giving a reason of higher interest rates or higher risks or high beta that will be built in the CAPM to confuse the common reader. True, it can happen but atleast I do know that the company has some reasons for the change in such forecasts.

1 comment:

Anonymous said...

Hoping that this "amateur analyst" wouldnt end up confusing the common reader by doing arbit forecasting :P