Sintex's Auditor Resigns. How You Can Protect Yourself from Such Stocks - The 5 Minute WrapUp by Equitymaster
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Sintex's Auditor Resigns. How You Can Protect Yourself from Such Stocks

Jul 20, 2018

Kunal Thanvi, Research analyst

Over last several weeks I've written to you about auditors resigning left, right, and centre. I've highlighted poor corporate governance in the mid and small cap space.

Week after week it's the same story. We see companies putting up notifications on the stock exchanges about the auditor's resignations.

The notifications may be worded in any of these versions:

  • Auditors resigning due to lack of financial information provided by the company.
  • Auditors resigning as they are busy with other clients.
  • Auditors not interested in continuing their tenure.
  • In some cases, auditors simply resigning without giving any explanation.

This is funny but annoying as well.

I mean it is funny because why now? Why do these auditors want to run away from these questionable companies now?

As far as the corporate governance goes, nothing has changed much in India over the last decade.

Perhaps the answer is the National Financial Reporting Authority (NFRA). Time will tell.

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And it is annoying because, when auditors resign abruptly, the stock goes into a free fall. It's ordinary retail investors who are left with huge losses.

In many cases, the stocks hit lower circuits for few days and the retail investors have no clue what has led to this massive fall.

In fact, in many cases, they end up buying more...but the stock turns out to be a falling knife for them.

Last week it happened to a company with good brand visibility but bad management.

Remember the Plastic Water Tank Company - Sintex?

Yes, I'm talking about Sintex... the company that has a strong brand in rural India.

Most of us know about Sintex water tanks and how it has been part of our homes, helping us to store water.

The brand recall has only gone up over the years.

But there has always been a big question mark on the management. I'm talking about their corporate governance and their capital allocation.

Sintex was into two businesses - plastics and textiles.

Last year, the management de-merged the two. Many shareholders made a killing.

But I always wondered why a plastic company, with such a good brand, wanted to stay in the textile business. It uses up a lot of funds and very little is left over for shareholders.

Not just this, the promoter holding was low and they had pledged a part of that as well. All this put doubts in my mind.

Last week, the auditor of the plastics business resigned. The quarterly results were also poor.

This reinforces my belief. No matter how strong a business, if it's run by questionable management, the aam investor may end up losing money.

Just look at today's chart. I'll show you how this company fared on the Smart Money Score.

I've said it before and I'll say it again. Many more auditors will resign and run away from unethical managements.

Now, I know this has created a lot of fear and uncertainty. I understand your worries dear reader.

I believe when it comes to investing in stocks, safety is as important as growth. This is why I developed a tool to protect the aam investor - the Smart Money Score.

It helped me stay away from Sintex, Manpasand Beverages, Vakrangee, PC Jeweller, KRBL, Inox Wind and others. I'm happy I could protect my subscribers to Smart Money Secrets.

I strongly believe, what is happening is good for the market. It will change the course of Indian corporate governance.

And once the dust settles, companies with good corporate governance will sail ahead.

Companies with questionable track records will either go out of favour or will have to adopt good practises.

This process has already begun. I can find more high-quality stocks now than before.

For example, on Monday 23 July, I'll publish my next recommendation. If you're a subscriber to Smart Money Secrets, expect it in your inbox after market hours.

If you don't have access to Smart Money Secrets, you can sign up here.

Happy Quality Investing!

Chart of the Day

I've written to you about the tool I developed - Smart Money Score. It helps me to side step obvious and stupid mistakes.

Today, I thought I'll show you how it really works.

Every company recommended to Smart Money Secrets subscribers needs to pass this proprietary checklist.

I tested Sintex (pre-demerger). This is what I found.

The company failed horribly on almost all the metrics.

If I Find a Company Like This, the Smart Money Score Will Reject It

These eight indicators are very important to me. They broadly take care of all the important aspects I check before recommending any stock.

Each indicator has 10 points. But I assign higher weightage to Business Quality (ROEs, D/E, Cash Flows) and Corporate Governance (Earnings quality/ Management Integrity).

Just look at Sintex.

Promoters have been reducing their stake (they've issued FCCBs).

Over last five years, then average ROE was 12-13%.

It had a debt to equity ratio of above 1.

It does not stop here. The list is long.

The promoters have pledged their shares. They have misallocated capital time and again.

Thus, I got a rating of 3.25 out of 10 for Sintex.

And just to give you a perspective here... for any company to make the cut, it should have a rating of at least 6 out of 10.

I have never recommended a company with a score below 6-7. In fact, in most of cases it's more than 8.

It may be difficult to predict when an auditor will resign.

But it is relatively easy to know which stock you should avoid.

In fact, sometimes even research analysts fall for such stocks.

But the Smart Money Score plays a big role in keeping us away from such stories.

Happy Smart Investing!

Regards,

Kunal Thanvi
Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stocks that won't put your wealth in peril, subscribe to Kunal's Smart Money Secrets.

Note: Sintex informs us that their auditor, R Choudhary, did not move out before the announcement of Q1 results. Also, Sintex has informed us that they have appointed BSR, a KPMG firm, as their auditor. You can read Sintex's submission to the BSE here. While we felt it necessary to share this with our readers, we stand by our view as published.

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1 Responses to "Sintex's Auditor Resigns. How You Can Protect Yourself from Such Stocks"

K C Seetharaman

Jul 21, 2018

When the auditor does his job totally independently then the client will invaruainv have disagreements with him. So the Auditor has two alternatives.
1 Agree with what the client is proposing
2 Resign
One can expect quite a number of resignations coming and actually it should be like that so that the Financial reporting is done correctly.
I don't think any other Auditor would accept Sintex Audit without talking to the earlier Auditor and doing the corrections.
It is great that Auditors have taken the stick and this is going to snowball into more.

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