Infosys: How analysts missed the wood for the trees

Infosys: How analysts missed the wood for the trees
IT major Infosys, part of India's $100 billion outsourcing industry, surprised the Street with its full year revenue guidance on Friday.

Most analysts had expected Infosys to cut its organic sales forecast from 5 per cent to as low as 3.5 per cent for 2012-13, but Infosys not only retained its full year sales outlook at 5 per cent, it also said that its consolidated sales will grow by 6.6 per cent in dollar terms. The stock surged 17 per cent adding over $4 billion to its market capitalization.

The company's earnings, while impressive, are also a reflection of how analysts can go completely wrong in their forecast even when large and widely tracked firms are concerned.

Some analysts, however, have pointed that their pessimism about Infosys' outlook arose after a series of interactions with the management in early December, when the company sounded extremely cautious and indicated that it might not achieve what it promised earlier.

Considering that Infosys had been a rank underperformer over the last few quarters, analysts were quick in predicting a downward revision in sales outlook and earnings per share.

Post the earnings announcement, Infosys chief executive S.D. Shibulal said: "In the middle of the quarter, we had seen headwinds. We had seen headwinds from furloughs, which were more than expected and their longevity had increased. There was an impact of super storm Sandy. We have mitigated it simply through hard work. Our people have worked very hard..."

What most analysts probably missed was Infosys management might be adhering to one of the basic tenets of accounting known as the 'Principle of Conservatism', which states that expected losses are losses but expected gains are not gains. The principle, a guiding force behind a number of Indian accounting standards, requires companies to report the probability of bad news immediately, but prevents them from sharing expectations of good news until the positive events have actually occurred.

This principle is widely used in Accounting Standard 9, which deals with revenue recognition and in Accounting Standard 20, which talks about earnings per share.

The Infosys management rightly signalled to its shareholders that earnings might be under threat because of customer deferrals, ramp-downs in some large projects and longer-than-expected client shutdowns due to Hurricane Sandy. However, most analysts narrowed their focus on this aspect and missed the bigger picture such as revenues from large deals in previous quarters kicking in or how Infosys has become fiercer in winning deals.

The management warning lowered investors' expectations ahead of the results and, coupled with the fact that these events did not hurt earnings as much as expected, did wonders for the stock.

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