Parak Parikh, CEO of PPFAS one of the well known Portfolio Management Advisers and relatively conservative broking house has beautifully written why stock price targets have been cut by as much as 50-60%. This is what he terms as the “double whammy” / double edged sword of lower profits and lower valuation.
It is common that during the final stages of bull market hype, most investors fall prey to the “Greater Fool Theory” ignoring all advise. Now how is this related to earnings downgrade ?
Well, lets say a company reports a fall in profits due to rising costs and inability to raise prices sufficiently to offset these costs. To add to their woes, staff and admin costs have also increased and put a further strain on net profits. This would of course lead to lower profits in subsequent quarters and the company may see its net profit contract by about 40-50%. The problem is that when this happens, the growth multiple assigned to a company will also correspondingly fall because of lower
expectations for growth.
Hence always use a valuation strategy before you buy into any stock. Think that you are acquiring that business and you have to be profitable in your acquisition. So this explains why we always write down EPS expectations etc in every report we publish here, so that even at times if we are blind, you may take a call based on the fundamentals and growth of the business.