»5 Minute Wrap Up by Equitymaster

On This Day - 31 OCTOBER 2015
The Management Talk that Makes Sense to Us

In this issue:
» The ensuing change in India and China's demographic dividend
» Why has SEBI failed to lure startups?
» Will frugal R&D spend hurt India Inc?
» ....and more!


Frankly, if I were to shut off my Web and shut off the TV and just look at how many customers are coming into our stores... I wouldn't know there were any economic issues at all in China.

That was Apple CEO Tim Cook on whether the Chinese economy is affecting his company's growth prospects. Cook expressed little worry about Apple's historically low valuations in his latest conference call address to investors. And he made no attempt whatsoever to reason for the below-expected performance in the latest quarter. As ever, the focus of Apple's management was on creating demand for its products and what to do with its bulging cash flows.

Unfortunately, Indian companies also do their best to merely please and comfort investors during conference calls. Attending these calls is an easy way to gauge the consistency of the captain's thoughts, but rarely do they reveal much that takes place in boardroom discussions. Apart from some capex plans, most managements divulge little in terms of the big growth drivers. And they hardly ever speak of challenges - that is, until they begin to reflect in the earnings growth. In fact, most CEOs and CFOs are much too content to merely reiterate that they have met or exceeded the earnings guidance for the quarter.

And so we're delighted when management talk departs from these norms...

For instance, the promoter of an auto ancillary company, a company we have recommended in StockSelect, earlier (subscription required) spoke of guidance for 2018.


It is not every day that you hear companies talk about where they see the business heading in three to five years. When pressed, most will just say they are focused on the next four quarters. So it was a delight to hear this gentleman speak of the company's 2018 targets and explain why they will be met despite the headwinds facing the sector.

Similarly, a few months back, the management of a niche garment company (again, one that we recommended) had the challenge of assuaging analysts about its disappointing first quarter performance. But instead of playing victim, it focused on the direction the company's revenue stream and profitability over the next few years. It spoke of plans to build brands, create franchises, and strengthen its moat.

But it is not just about managements being brave when questioned about their recent underperformance. There have been instances of management warnings analysts that margins are at the peak when congratulated about their performance too. Here again they don't speak of the next quarter but about what to expect when the cycle turns after several quarters.

It is a pleasure to listen to outspoken managements who can communicate deep insights into their business. We praise managements who fearlessly communicate to their minority shareholders and who take responsibility for their ‘management skills'.

So don't be surprised when we say that we are hesitant to recommend an IPO when we have hardly ever heard enough from the management. Don't be surprised when we say that the latest earnings conference call made no sense to us. And don't be surprised when seek out real replies to our questions. More importantly, don't be surprised to learn that most management talk that that media reports has little relevance to your long-term investments.

We keep our eyes and ears always open for management talk that makes sense. As an investor who wishes to own businesses for the long term, you too should look for companies who communicate effectively.

Can you share instances where the communication from the company's management during a crisis did not make any sense to you? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
During the economic boom of the 1990s and 2000s, it became fashionable to talk of India's forthcoming "demographic dividend". This was quite a turnaround from the worries of bulging population in select Indian states. The experiences of East Asia and the demographic dividend it benefited from became a reason to be positive about India's future.

Working-age population in India rose at the same time as the ratio of dependents to workers fell. An associated rise in the rate of saving allowed scope for more investment. It was hoped that these savings will pay for the growth in manufacturing which would employ millions and lift people out of poverty. The timing of India demographic divide, as acknowledged in the BRIC report, was particularly encouraging. India's labour force was due to soar as China's began to decline.

Almost two and half decades later, is the equation in India and China's demographic dividend set to change dramatically?

For China the key issue over the past few years has been rising dependency rate. Faced with the challenge of falling work force, China has put an end to its three decade old one-child policy.

For India, the challenge is to provide jobs to its growing working population. While it is quite uncertain whether the change of policy will help China catch up in the race for demographic dividend, it is time for India to stop being complacent.

Will China catch up in this race for demographic dividend?

Entrepreneurship and startups have been gaining much interest in India. In a very brief period, many people in the country have moved from being job seekers to job creators. Factors such as availability of workforce, encouragement to entrepreneurship, urbanization and availability of seed capital is fuelling boom of the start-ups. These start-ups generally prioritize scale, top line growth, huge market share, over fundamentals like sustainability, profitability, and margins.

The number of startups present in India now over 4,000. As these companies attempt to grow their businesses, they need more funds. These entities are believed to be important contributors to India's growth going forward. Hence, considering the capital requirements, SEBI had relaxed some norms to make it easier for startups to raise money from the home markets around four months back.

However, even the relaxed norms have failed to entice this group of entrepreneurs. According to an article in Mint, in the last four months, not a single entity from these startups have approached the regulator for raising funds from the domestic markets. In fact these startups prefer to access funds from western counterparts which could offer premium valuations for their business. Further they have quite relaxed norms as compared to India. On other hand these firms have been also lobbying to obtain further relaxation in the norms in India based on future growth potential.

No doubt some of these would be promising start-ups and thus they should not struggle for want of capital. However SEBI has drawn a well-defined line to balance the needs of startups and also protect investors' interest. Though these norms may not go well for the startups, we believe it is a necessary check to protect the interest of retail investors to some extent.

The US economy may have gone nowhere since the financial crisis in 2008. But prior to that, there was a reason why it became a force to reckon with in the first place. And that was because of its focus on innovation. So a country's ability to innovate is what will take its growth to the next level. Does India score well on this factor? Sadly, no. India's rank on the Global Innovation Index slipped from 23 in 2007 to 81 in 2015. One of the measures to gauge the level of focus on innovation is R&D expenditure.

According to an article published in the Mint, there has been a continuous decline in R&D spend of India Inc. since 2010. These companies spent Rs 10,000 in R&D for every Rs 1 crore of sales 10 years ago. It is down to Rs 5,000 now. The 2008 financial crisis has been one of the big culprits. But the slowdown in the Indian economy has also contributed to this. In an attempt to cut costs and spruce up the balance sheet and overall financials, the spending on R&D has also been curtailed. Certain sectors typically spend more on R&D than the others. Pharmaceuticals, automobiles, electrical firms are some obvious examples. But even in the case of these the R&D spend as a percentage of sales has come down. Lack of skilled manpower has also hampered the focus on innovation. For Indian companies, overcoming these challenges will not be an easy task. But it is necessary if these companies harbour ambitions of becoming an economic force to reckon with on the global map going forward.

Global markets closed the week on a negative note with a majority of the indices ending in the red. The stock markets in Brazil (down 3.6%) and India (down 3%) were the top losers

During the week, US gross domestic product (GDP) increased at an annual rate of 1.5%, down from 3.9% in the second quarter, according to the Commerce Department. However, consumer spending, which accounts for more than two-thirds of US economic activity, grew at a rate of 3.2%. The Federal Reserve on Wednesday kept interest rates unchanged at their record low of near-zero levels. However, the committee specifically pointed towards the possibility of raising rates at its December meeting. The stock markets in the US were down by 0.1% during the week.

Also in the previous week, China's central bank cut interest rates for the sixth time in less than a year. The majority of the Asian markets ended the week on a negative note. The stock markets in Singapore and Hong Kong were down by 2.3% and 2.2% respectively during the week.

Back home, the Indian markets ended lower by 3%. The earnings season has surely disappointed the investors. The disappointment over the Q2 earnings season coupled with the Fed's hints at a possibility of a rate hike in December hurt the investor sentiments and dragged the markets down.

Performance during the week ended 30th October, 2015

 Weekend investing mantra
"The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts."- Warren Buffett

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