24 April 2015

HDFC Bank & The Expectations Treadmill

Imagine, there are two students X & Y. The first student, X, is a star student and always scores an A grade. The second student, Y, is an average student and always scores a B grade. In a certain examination, both students score an A grade. The 'reward' received by the average student will be more as he has beaten expectations. The expectation from the average student was to receive an average grade and by achieving an above average grade he has beaten those expectations. Whereas the star student has delivered what he always delivers i.e.: he has met his expectations. Further suppose, that in a later examination both of them score an A grade. In that situation, one would say that both have met their expectations.

The reference point for expectation is current performance.  To continuously beat expectations, star performers need to work harder and harder as expectations are higher and higher. In corporate finance, this principle is often termed as the expectations treadmill (To my limited knowledge, the phrase was coined by McKinsey consultants). Here is an excerpt from Valuation: Measuring and Managing the Value of Companies (a publication by McKinsey & Co.), which explains the treadmill with respect to companies (screenshot taken from Google Books) :

HDFC Bank came out with its Q4 Results yesterday. Following are some quotes from this report :

"HDFC Bank Ltd’s steady performance in recent times hasn’t set its stock on fire."
"Its March quarter net profit growth of 20.65% also didn’t excite investors in a tepid market."
"Although the bank has been delivering a steady net profit growth of at least 20% in the past eight quarters even when economic growth was sluggish, it is still a comedown from the pace of the four years prior to that. At that time, the bank delivered a 30% net profit growth quarter after quarter"
"To be sure, it has comfortably beaten the industry loan growth rate, as has been its practice"
"That doesn’t seem to be enough for a bank that trades at the highest valuation among the world’s largest banks, according to Bloomberg data. To generate market-beating returns over the medium term, HDFC Bank will have to get back to its old ways of 30% profit growth."
Thus, even though HDFC Bank is probably best in class with respect to growth and returns and that its latest results might be the best among private banks, it still failed to excite investors. The expectation from HDFC Bank was to beat its past record. Such is the strength of future expectations. (As of writing, the share price of HDFC Bank has changed negligibly)

Well, I will end with the wise words of Shakespeare, which might not be absolutely fitting but are wise anyway :
"Expectation is the root of all heartache"
- William Shakespeare

1 comment:

Devna said...

Heartache / Headache.. tomato tomAto ;)