Infosys and the Funny Stock Market Pastime Called ‘Expectations’

India’s leading software company, Infosys announced its September quarter result yesterday. The company reported an 8% growth in sales during the quarter, as compared to the previous quarter ended July 2011. Its profit growth stood at 11%.

The stock clocked gains of around 7% after these result was announced. Now, if you think the good performance from the company was the reason for the stock to have performed so well yesterday, you are missing the point.

The key reason the stock rose so sharply was not Infosys’s September quarter performance, but the fact that the management raised its ‘forward guidance’ or its ‘earnings expectations’ for the coming quarters.

Once upon a time in 2003
I still remember that day in April 2003, when I was just a week into my new job as a stock market analyst. I was then handling the software sector, and thus Infosys came under my coverage.

The company had just announced its result for the quarter and full-year ended March 2003. For the full-year, it had recorded 39% and 19% growth in sales and net profit respectively.

Now you would imagine that these were pretty good growth numbers, right? I did.

But to my horror, the stock crashed by 37% over the next two days. Imagine losing one-third of your capital in a span of two days. How would you feel?

I was not an investor in Infosys then, but being new to the stock markets, and in charge of research on Infosys, I got confused, and at the same time, scared seeing such a sharp fall in the stock price.

“What’s wrong with the markets?” I asked my senior colleague. “Infosys has reported such a good result, so why has its stock been punished so badly?”

“Look at the expectations,” he told me.

“The company has guided for a 24% growth in sales and 12% growth in profits for the year ending March 2004. I think that’s not a poor guidance anyways!” I argued.

“Yeah, but that’s poor as compared to the analysts’ and markets’ expectations from the company!” he replied. “The markets are nervous about the company’s earnings expectations for the coming year, and that’s why they have hammered the stock down. It’s as simple as that!”

“So who’s the culprit here? The company? Or the analysts?” I asked.

“I’m not sure about that,” he told me, “But this is how stock market works.”

This final thought – “This is how stock market works.” – has stuck with me ever since.

But what seemed scary then – the way stock market and its expectations work – now seems funny.

Games people play
If you are an investor in Infosys – and even if you aren’t – you must know how people in the stock market behave just before and after Infosys announces its quarterly result.

The day the company’s result is scheduled seems like a festival on business channels, with anchors and stock market experts wearing their best clothes and sporting their best smiles before the result is announced.

Forecasts about how the company would’ve performed during the quarter continue to pour in till the second before the actual result is announced. And then once the result comes in, there is a whole lot of discussion not just on how the company performed, but more importantly how it performed vis-à-vis the ‘expectations’.

Everyone seems an expert and everyone seems to have got the predication right.

Then the management is questioned for hours – less about how it sees the business doing over the next 3-5 years, and more about how it sees it doing over the next quarter, or at best, two quarters.

‘Expectations’ is the most-used word that day, and the way Infosys’s stock price moves after the result announcement has also a lot to do with ‘expectations’.

Look at the stock’s yesterday’s performance. The biggest reason the stock price rose after the result was announced wasn’t the result itself, but the announcement of improved earnings expectations from Infosys’s management.

Now, the analysts will rework their numbers and show earnings per share (EPS) estimates for the year ending March 31, 2012 to be closer to the Rs 145 number that the company has indicated.

They will write ‘Buy’ reports (where were they a month ago?) and fund managers (not known for their wisdom) will follow the analysts and buy Infosys’s shares.

Believe me, this will happen, as it has happened (without fail) over the past many years.

Higher expectations will take Infosys’s stock price higher, till the time the management announces, “Hey, our company’s earnings will not grow as fast as you have been ‘expecting’ it to grow.”

And then, all hell will break loose as the stock market’s expectations will be dashed. The stock will be dumped.

That will be a good time to buy the stock.

It’s your choice
As funny as it may seem, silly short-term expectations of analysts, fund managers, and business channel ‘experts’ will continue to play on Infosys’s stock price.

Analysts will continue to change their expectations every month – as frequently as they change their jobs – and be wrong most of the time.

Fund managers will continue to buy and sell Infosys’ shares depending on which analyst they listen to.

In the meanwhile, the management team at Infosys will carry on their job of building one of the leading software companies in the world…and one of the most profitable ones.

It’s upon you, the investor, to know which side are you on.

Will you be happily playing the short-term expectations game yourself, or will you be judging the stock’s worth by the company’s long-term business prospects and the management’s ability to steer it in that direction.

The choice is yours. It has always been.