Case 089Earnings and resultsCore
A pharma company cuts growth guidance from 12% to 7%. Your EPS estimate falls from Rs 48 to Rs 43 and the stock drops 15% from Rs 960 to Rs 816. How much of the cut is already priced in?
1The situation
Ishvani Pharma sells generic medicines in the US and branded ones in India. On its results call it cut revenue growth guidance for the year from 12% to 7%, blaming faster price erosion in the US generics market. You cut your EPS estimate for the year from Rs 48 to Rs 43.
The stock fell 15%, from Rs 960 to Rs 816. A colleague says the stock now trades at 17x earnings, well below its usual 20x, and looks cheap. Indian generic peers growing 6% to 8% trade at about 17x.
2Your task
Split the fall between the EPS cut and any change in the multiple, and say how much of the bad news the price now reflects.
Quick check
What P/E does Ishvani trade on now?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The whole EPS cut is priced in, plus one turn of de-rating, but not yet a full re-rating to a 7% grower. At the old 20x, EPS of Rs 43 is worth Rs 860, so Rs 100 of the Rs 144 fall is the EPS cut. The other Rs 44 takes the multiple to 19.0x. Slower peers trade near 17x; if Ishvani converges there, the stock is about Rs 731. If growth recovers, 20x puts it back near Rs 860.
Step 1Which P/E is the honest one?
Pair the price with the EPS of the same moment. The colleague's 17x divides today's price by yesterday's estimate. A P/E on a stale EPS makes any stock look cheap after a cut, because the earnings in the denominator have already been withdrawn. Rs 816 on the new Rs 43 is 19.0x. It is like judging a flat's rental yield on last year's rent after the tenant has negotiated it down.
Step 2How much of the fall is the cut, and how much is the multiple?
Move one piece at a time. At the old 20x, EPS of Rs 43 is worth Rs 860: that Rs 100 is the EPS cut. The remaining Rs 44 takes the multiple from 20.0x to 19.0x. When the price falls about as much as EPS, the market has priced the cut without a de-rating; Ishvani fell 15% on a 10.4% EPS cut, so it priced the cut and de-rated by about one turn. That extra turn is the market's first charge for slower growth.
Step 3Is one turn enough for a 7% grower?
Compare with the companies Ishvani now resembles. Generic peers growing 6% to 8% trade near 17x; at 17x on Rs 43, Ishvani would be about Rs 731, another 10% lower. If the price erosion is temporary and growth returns toward 12%, the old 20x on Rs 43 gives about Rs 860. So the price sits between the two readings, closer to the recovery case. The market has priced the cut; it has not yet priced 7% as the new normal.
| Reading | EPS, Rs | Multiple | Value, Rs | Against Rs 816 |
|---|---|---|---|---|
| Growth returns toward 12% | 43 | 20.0x | 860 | +5.4% |
| What the price assumes | 43 | 19.0x | 816 | 0% |
| 7% becomes the new normal | 43 | 17.0x | 731 | -10.4% |
The evidence that decides which way it goes: the pace of US price erosion on Ishvani's top ten products next quarter, new product approvals that could restore growth, and whether India branded sales, the steadier half, hold their growth. Close with the limit: guidance cuts often come in pairs, so ask whether the new 7% is itself conservative or still hopeful.
Where candidates lose it
The colleague's mistake is the trap: dividing the new price by the old EPS and calling the stock cheap at 17x. The interviewer wants to see you refuse to mix a price from today with an estimate from yesterday.
The second loss is saying the market overreacted because the price fell more than EPS. A lower growth rate deserves a lower multiple; the question is whether one turn is enough, not whether any de-rating was fair.
What the interviewer asks next
- If you also cut next year's EPS by 8%, what multiple does Rs 816 imply on next year?
- What would make you think the 7% guidance is conservative?
- How would you present this to a fund manager who owns the stock?
Company names and figures are illustrative.