For years, I have been screaming that Management Quality is the key to investing well. World over, research reports from the Sell Side (brokers) never mention this factor or cover even two lines about the promoter or management while advocating a buy on any company stock. The large brokers are afraid of promoters. They get or hope to make fee income from investment banking business with them.
Equity Research is a ‘cost’ and buy reports help them in two ways. One is to get some brokerage revenue, since buy reports are what they call as “actionable”. A “sell” does not fetch business. More important, promoters will black list brokers who have a “sell” on their stock.
I was in this industry on the ‘sell’ side, in the early 1990s. We followed the American model. Which was that research is a ‘cost’ centre. It helps to drive business in to wholesale stock broking (institutional customers) and also helps them to get investment banking mandates with clients on whom you put a “buy”. It was understood that when a ‘pitch’ for a deal is being made, the research team is either expected to put a buy or keep quiet.
Nothing negative is on.
So, it is no surprise that no research report from big sell side firms carry even two lines on ownership or management quality, unless it is to praise them.
Over the last few months, we have been seeing ‘surprises’. Of defaults, frauds and audit issues etc. In fact, I think it will get worse.
In every case, it is obvious that the management quality has been the issue. And it is not as if this is a surprise to anyone who follows business. One would expect that each and every ‘sell’ side broker or analyst would have told this to you if you ask him ‘off the record’. And you can bet that not a single sell side analyst would have put his own money in those stocks, citing ‘compliance’ issues etc.
In the older established companies, it is easy to know about management quality. There is enough knowledge in the market players. As regards new business startups, one has to dig deeper in to their backgrounds. And look for warning signs. There are many warning signs which can tell us about promoters.
History is important. Before you invest serious amounts, if you do not do a promoter check, you run the risk of being surprised at some point in future. Today, the net is a fantastic source of information. Plus, use whatever connects you have- from vendors, employees, ex-employees etc to get some idea of the promoter. Do not watch the promoter on television and form a view. These persons are coached to present information and are engaged in talking up the share price. So if you are addicted to business television, the miniumu you have to do is to mute the channel. Ideally, it should be off.
A rough and dirty approach is to shortlist companies for investment based on whatever criteria you have and then put it to the management test.
Of course, often you are influenced to buy things without giving serious thoughts, simply because someone else is buying or pushing it. And you feel that the price will run away. I find that this route generally leads to losses. Be safe. At worst, it could be a lost opportunity. In investing, I believe safety of money is important.
When there is a gun pointed at your head and you have to decide, say “no”. You can always change a no to a yes. But a yes under such circumstances could result in damage to your wallet more often than not.
What I also find is that good quality management also gets reflected in fina-ncials. Consistent ROE or ROCE, steadily declining debt are qualities I look for. Even if I have no negative feedback, I can usually find some connect with management quality if financials are poor. A good promoter will ensure that he deals with other shareholders fairly, keep his holdings high.
Divide the universe in to three groups: Family owned, independently run and government owned.
In the independently owned ones, lay emphasis on financial analysis. In the family owned, keep probing. And even after you invest, keep tracking the promoter and keep searching. Presume that everyone is out there to get you. That way, you avoid disappointments. Do not put very large chunks of money behind one promoter. Keep a discipline of limiting your per company or per promoter exposure. Keep looking for signs that are red flags such as:
n Changing accounting policies;
n Increasing total debt;
n If a long list of lenders does not have the well-known private banks;
n Interest capitalisation;
n Preferential allotments to promoters;
n Decline in promoter shareholding to below 30%;
n Too many subsidiaries and affiliates;
n Family shareholding in subsidiaries;
n Poor ROCE;
n Recurring capital expenditure and weak ROCE;
n Continuous acquisitio-ns of unlisted companies.
There is no defined template. When you go in with unknown quality of entrepreneur, your money is like venture capital. Often, it becomes ‘ad’venture capital if you do not do some basic checks.
(The writer is a veteran investment advisor. He can be contacted at balakrishnanr@gmail.com)
