Would You Partner With a Promoter Who Rewards Himself Handsomely? - The 5 Minute WrapUp by Equitymaster
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Would You Partner With a Promoter Who Rewards Himself Handsomely?

Jan 12, 2016
In this issue:
» Raghuram Rajan Talks tough!
» Why bottom up investing pays
» ...and more!
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Devanshu Sampat, Research analyst

It was a while ago that I discussed a stock idea with a colleague of mine - a member of the research team - over some chai. Being a business from the commodity space, its stock had gotten hammered black and blue in the year gone by to trade at multi-year lows.

What got me particularly excited about the stock was that it was trading way below book value. A near 30% discount from what I can recollect. My excitement was augmented by the company's stellar 10-year track record, a period long enough to encompass the best and worst of a full economic cycle.

On asking my colleague his views on the business, he rhetorically replied, 'Why would you want to tie up with crooks!' He was referring to an action the management had announced that was against the interest of the minority shareholders.

His retort helped me back up a few steps and look at things from a broader perspective, particularly that investing is buying a stake in a business; that one is partnering with the promoter.

Safe to say, we did not go ahead with that particular idea in any of our services...

Mind you, this was not an illegal step taken by the management; but such actions are one of the steps on how promoters can take undue advantage of their positions.

Another aspect investors must consider when partnering with promoters is management remuneration...a topic we have written about multiple times before.

Some cases, such as the following, only leave us scratching our head, wondering how managements can justify their actions...

I am referring to the difference in pay scale of promoters from the same business - Amara Raja and Exide Industries. The promoter of the former company paid himself a hefty amount of Rs 33.3 crores for the 2015 financial year. No doubt, the company has done very well, snatching market share from its rival. However, relative to the Exide's promoter, his salary is outrageous. In FY15, the MD, the Whole Time Directors, managers, and other Directors of Exide were paid a combined figure of Rs 10.3 crore.

And here's the best part... Gross revenues for Amara stood at Rs 46 billion, about 60% of Exide's FY15 standalone gross sales (Rs 77 billion).

The interesting bit here is that none of this is illegal. The management is taking commissions within the prescribed limits. But in the case of Amara, the management utilises the maximum limit of 5% of the net profits calculated under Section 198 of the Companies Act, 2013. In case of Exide, the management only took home about 12% of the overall ceiling limit.

While such discrepancies are not rare, some managements are much on the other end of the spectrum...

Professor Sanjay Bakshi recently highlighted how a very generous action taken by the promoter of a small-sized company went overlooked by the media. The management of this company went on to annul his 2% commission on profits. His reasoning was that he considers himself a shareholder of the company, just like the other investors, and would thus like to be rewarded with dividends.

Such situations get us thinking... Should one ignore management pay and focus on business quality and risk-reward ratios? Or is it true that every stock becomes a good investment candidate at a particular price?

Such thoughts cross every long-term investors' mind...and they aren't so easy to resolve...

When faced with such questions, it's always good to look to the greats for answers. Warren Buffett was in the news not too long ago for not voting against a hefty pay for the senior management at Coca Cola. While he received flak for his vote, he stood by his stance: 'I don't think [CEO pay] is out of whack with what the value is of an outstanding executive could bring.' He added, 'If you run a multibillion-dollar company, the difference between a ten and an eight [in terms of CEO performance] is huge in terms of value.'

Well...do you agree with Buffett?

Should investors look past the hefty salaries executives pay themselves and focus on the business quality instead? Let us know your comments or share your views on the Equitymaster Club.


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2:40

While we are on the subject of corporate governance and ethics, we wish to highlight a very interesting article we read in today's Economic Times. The employees of the Reserve Bank of India received a long and hard-hitting New Year letter from the governor Raghuram Rajan. The governor called on the RBI employees to be relentless in pursuit of wrongdoers. He implored his staff to be proactive rather than bureaucratic and to crack down on rule breakers.

It was indeed refreshing to learn the extent to which the governor is willing to go, in a bid to clean up corporate India's worst practices. The RBI has been pushing banks to clean up their books and go after defaulting promoters. The recent case of Electrosteel Steels being taken over by lenders, under the new SDR mechanism, is a case in point. We believe the RBI is indeed fortunate to have Dr. Rajan as governor. However, India's regulators have a long way to go before well-connected wrongdoers stop believing they are above the law.

3.35 Chart of the day

At Equitymaster, we emphasise bottom-up stock picking. We do this not only because it works but also helps us cut out the noise of the markets. With this approach, we don't need to pay too much attention to so called 'macros'. Today's chart points out a good example of this approach. The BSE Sensex closed at a 52-week low yesterday. The level was almost the same as that on 07 Sep 2015. This means the benchmark index has delivered no returns since that date. However, individual stocks have moved by significant amounts.

Sensex Flat But Big Moves Seen in Individual Stocks

We made this chart of the top three gainers and losers not from a recommendation point of view. We are in no way rooting for aviation stocks. Rather, we want to highlight the fact that no matter what the major indices do, there will always be opportunities and threats in individual stocks. It is important that investors view each stock on its own merits before taking the plunge.

4.40

At the time of writing, the Indian equity markets were trading weak with the Sensex down by about 107 points or 0.4%. Stocks from the mid cap space were trading weak (BSE-Midcap Index down 0.2%) while small cap stocks kept their heads above water with the BSE-Smallcap Index up by about 0.1%. Banking and telecom stocks were least favoured, while those from the capital goods space were in demand.

4.50 Today's investing Mantra

"At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it's going to go next week or next month or next year, a line of thought we never get into. 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

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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1 Responses to "Would You Partner With a Promoter Who Rewards Himself Handsomely?"

Col (Dr) A P Gupta (Retd)

Jan 12, 2016

The political will of the present day government and the desire of the RBI Governor to clean up the Augean stables will be proved the day, the most high profile wilful defauter- Vijay Mallaya- is put behind bars.

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Equitymaster requests your view! Post a comment on "Would You Partner With a Promoter Who Rewards Himself Handsomely?". Click here!
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