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Earnings Quality check on India Nifty stocks - Does your portfolio / mutual fund has the `next Satyam` ?

|Includes: WisdomTree India Earnings ETF (EPI), INDL, INDY, INFY, INXX, LTOUF, PIN, SCIN

Introducing a new series on Earnings Quality check – also called as SSEXI – Saanp aur Seedi Earnings Xittiness Index.
In Indian `hindi` local language , `Saanp` means Snakes , `aur`  means And , `Seedi` means Ladders.

Please note this is an excerpt of my detailed article. The full post is here.
So why name it as SSEXI not EQI ( Earnings Quality Index) ? 
My  goal is to not to establish a hall of fame but a hall of shame. For the former, there are numerous ratings such as ET,BS,BT ( Economic Times, Business Standard and Business Today).
I was bit frustrated by the lack of availability of decent earnings quality analysis on Indian firms by the reputed big brokers equity research desks. So decided to do this research.
I have done a study of ~ 25 India NIFTY companies (comprising ~ 61% of Market cap of NIFTY or ~ $0.8 Trillion. ( See the chart at my detailed post here below at the end.)
These are the companies I have studied :
  • Oil and gas –RIL,GAIL,ONGC
  • Capital Goods -L&T# ,BHEL
  • Power -NTPC
  • Telecom - BHARTI AIRTEL
  • Cement - ACC
  • Real Estate – DLF ,JP ASSOCIATES

Brief ending comments on the findings
  1. Satyam was a clear outlier with reported P&L numbers double the cash flow numbers. ( i.e actual PE of Satyam was double / 20x  vs then reported PE of 10x. Similarly P&L EBITDA to Cash EBIDTA ratio was 3x-4x). Even even big players such as L&T, Aberdeen Fund, Fidelity,J P Morgan, Morgan Stanley,,LIC, ICICI Pru,Singapore Sovereign fund were caught in this value trap. Yes , it is hard to tell if outright fraud is committed or not just by this ratio but at least it flags off valuation concerns and a fundamental value driven investor would have avoided the Satyam `value trap`. As per the table, for Satyam , the xit was actually hitting the fan. And had R Raju  not sent the letter of acceptance of the fraud I doubt if this would have been unraveled. Cases such as Satyam only shows the weakness of the system in catching such manipulation. Also had the cash from Satyam been put into a more liquid asset ( say Gold ETF`s vs real estate Land) , Raju could have easily raised liquidity and announce a big buyback at a huge premium. Even many IT majors such as IBM  was also in the fray to acquire Satyam. And had such a deal been pulled off then many of us would never have known this.
  2. Big drawback in India is that Balance Sheet and Cash Flow Statement is not disclosed quarterly. And recently SEBI required firms to report Balance Sheet every 6 months. Maybe this drawback one characteristic of an emerging market. 
  3. Till date ,out of this study sample of 25 NIFTY firms that comprise of 61% of total market cap of NIFTY, just four firms have released their full FY 11 financial statements (ending March 2011) – INFY,TCS,ACC and RIL. Will update this again after a month or so.Stay tuned to this site.
  4. IT Sector -Surprisingly for latest FY11 ending in Mar 2011,INFY and TCS have shown their NICFO ratios hitting the highest level in the last 4 years. This might indicate the pressure by management to meet the huge street expectations. CFO for TCS and INFY declined by -10%  and -23% respectively vs their reported earnings growth of +30% and +10% respectively. Thus as compared to the reported PE of 25x of both TCS and INFY, the actual PE ( based on CFO) is actually 35x. ( reported PE x NICFOR of 1.4x). If in FY11 this is the standard set by IT firms then I believe it would be very fair to assume that other sectors would be worse/ similar.
Please let me know your top pick for this rating ( i.e worst quality of earnings) by posting your comment on my blog here. I have also enabled comments posting as “Anonymous” i.e one can post a comment without the need to log into your email account.
Also let me know , if you have any stock that you want this check to be done. I cant promise it will be done but within my time constraints, I will try my best to close it.  My next objective is to do this similar SSEXI rating on my potential list of multi-baggers ( ~ Top 40 stocks)