Future Order Book: What Does it Mean?
This post is based on a question from one of the readers, “I sometimes see research reports of various broker-houses. They show future EPS. They say company has orders lined-up in order book. I am not sure how to get order book details and Future EPS of a company”. I thought this was an interesting question in a sense that how it is interpreted by us as individual investors. Like everything, this also can be interpreted in multiple different ways.
In my view, there is no effective way to measure the impact of future order book on future EPS. Theoretically, it is possible to translate this into future EPS. But I believe it can only be done by company executives. It is company insiders who know the operating cost, raw material cost, possibility of order completion, taxation, and when the revenue is likely to be realized (i.e. received by the company). I cannot understand how brokerage houses or independent analyst can make that estimate. I would like to know if anybody can share the methodology? To me, it only has a marketing value, nothing beyond that. Let me use an example.
Recently, I discussed return of investment from TIPBlog where I showed intangible (difficult to quantify) and tangible (direct revenue) benefits. I showed that the revenue is $1047 for last 10 months. Considering that it is a company and it had publicly traded shares to stock exchanges. There are two perspectives.
- One perspective is from company insider. Only I know that direct ads are fixed time based revenues. They will get over in say somewhere between 12 months to 24 months. Now, for company (i.e. TIPBlog) to really grow, the company needs future orders of $550 plus more. At a minimum the company atleast needs $550 to just replace the existing revenue. And to grow company needs more. Company executives can make some estimates based on its operational variables. In my blog case, I can make estimate of my future earnings, depending upon my interaction with marketers and advertisers. Again note that they are my best estimates only. I may or may not be able to complete them, or may get canceled half way through, or may get canceled altogether. As an outsider, you will never know what levels of orders are getting completed, or what level of orders are just to replace the existing orders, or what levels of orders are actually for growth?
- Second perspective is from brokerage houses. I really do now know how one can incorporate impact of order line-up to EPS estimate. I am running my company TIPBlog. How does a brokerage house know what are my costs and what is my future expected contract situation. Right? Either they have insider information or they will again use estimates from company executives (i.e me in case of TIPBlog). The business model at brokerage houses depends upon buying and selling the stock. They have to either recommend buying the shares or selling the shares. Otherwise how will they earn brokerage commissions? There is a general perception that lined-up order books is good, therefore, it is used as marketing tool to drum up the case for buy recommendations.
Summary is….
Brokerage houses do not have their hard earned money on line. It is our hard earned money that is on line here. As individual sane investors, the only parameters that we can have access to are its financial statement of past and its annual report. What is important to understand is how the management is running the company? Are they making effective use of capital to make increased profits?
Do not get me wrong. I am not saying future order line up is not good or it has no meaning. It does matter. However, I am not aware of any effective method to translate to future EPS. Therefore, we should look at other parameters and not focus too much on order books.
calculating future EPS, future EPS, future order book, return on investment
Hi Tip-guy,
You’re bang on.
I think a more perplexing question is the evaluation of management integrity. While as individual investors, we always look for past financial statements, yet the Satyam saga has taught us that they can be fudged too. In the past [ for older readers], there have been examples galore: MS Shoes, NEPC Micon, HFCL, the aqua companies, etc etc.
Can you write a blog on how we as individual investors can evaluate the management on integrity? I think in today’s post Enron/Satyam world, this assumes paramount importance.
Cheers,
Arun
Hi Arun,
Management integrity is a tough one. In this age, even the ones who you have known for long time, may change color for money and fame. So there are no financial metric that can effectively judge that.
Enron was a sham and there were quite few folks who new it is going to blow. Even Buffett has said it hard to beat folks who are hell bent on cooking books. I had one of my blogger friend with value investing bent look into Satyam financial (no not Rohit C). It were water tight.
What I have been doing so far is read into chairman speeches, and look for vision and consistency year over year. Not a fool proof or valid process, but something to give myself pseudo-satisfaction.
This is good suggestion which will require some serious thought. I will ponder over it.
Best Wishes,
Bull’s eye.
I never expected a full article on it. Thanks for clear this big doubt.
I really appreciate that you considered my question.
Also, as you mentioned earlier(reply to my comment), that the timeframe we are looking to remain invested in a scrip doesnt warrant checking of books.
Thanks again.
Regards
Yogesh Tiwari
You are welcome. I am happy to answer such questions.
Best Wishes,
TIP Guy,
Happy New Year.
A lot of this is public information. What is often done is that analysts speak to the management. The Mgmt tells them all the order related info that can be publicly disclosed. Even investors can ask for this information and cos. are bound to supply it.
The rest is only calculation with assumptions like cost/revenue ratio will be same or will improve etc.
Also, there may be some conclusions drawn from ongoing company strategies like focus on certain areas of business etc.
I am not an analyst etc. but I think they put a lot of hard work in these forecasts.
Regards.
Hi Siddarth,
This guy(in the link below) has something to say in his article. (Read between the lines)
http://valueinvestorindia.blogspot.com/2010/01/stocks-tips-are-not-portfolio.html
I m not saying that Analyst dont put efforts in evaluating a scrip. However, we have seen/read, nearly all such research reports tend to propose their targets based on future earnings.
Here on this blog, we tend to be biased to historical data for investing.
Regards
Yogesh Tiwari
how do u get the fair value of the stock. i mean say bharti is trading for 325 today but that can not be taken as a fair value, so how do u understand what is the right price for the stock to buy… looking forward to ur reply and what is the easiest way to getthe PE of the stock.
Hello Sunil,
You should looking into other areas on this blog. On the menu bar above, check out “my process” and “toolbox”.
You should also look at any on my earlier analysis. On side bar >> category >> analysis.
Feel free the ask questions that you may have.
Best Wishes,
Thanks buddy…
TIP Guy
Very composed & clear thoughts. Thanks for this article. By reading this I am more against brokerage houses.
regards
MIP
thanks MIP.
This is a general comment. Nice website i follow it regularly. keep up the good work.
I found a link for you u might find interesting. You paper on NIFTY Expected Returns for Different Trading Time Scales has been refered here.
[Link edited out]
Hello Jagan,
I did not get the link, can you please send it using “contact me” form.
Thanks,