I Start Worrying When Promoters Worry About This... - The 5 Minute WrapUp by Equitymaster
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I Start Worrying When Promoters Worry About This...

Apr 13, 2016
In this issue:
» Public sector banks suffer the most defaults
» Monsoons expected to be above normal this year
» ...and more!
0:00
Radhika Pandit, Managing Editor of ValuePro

In most countries around the world, including India, companies have to release corporate results every quarter. Quarterly earnings season is the most anticipated event for the stock markets.

The problem is this encourages a short-term outlook. In the investing community, analysts and brokerages come up with estimates for every quarter. If the actual earnings are below consensus, stocks see heavy selling. And vice versa. As brokerages are expected to get their quarterly projections right, many a time they emphasise a lot on the management giving performance guidance every quarter. The bigger picture is lost in the process.

It's alarming when managements care more about meeting consensus estimates than the fundamentals of their companies.

There was an interesting article in the Wall Street Journal about this. Patricia Dechow of Berkeley's Haas School of Business and three co-authors screened for nonfinancial firms that were subject to enforcement actions for misstating earnings. This is at some point between 1994 and 2010. They then looked at how these company's earnings compared with analyst estimates during the misstatement period.

They found that 53% of misstating firms topped estimates for at least four consecutive quarters versus 43% for other firms.

That's a big difference. It means that the managements of those firms were using various tricks and tools to ensure their 'actual' earnings beat the consensus estimates. They were concerned more about the company's stock price not crashing than managing a sound company. Of course, even if you cook the books, it's hard to always meet consensus expectations. So when there was finally a quarter when earnings lagged, investors were disappointed and the stock prices crashed.

This study was for the US; these findings don't necessarily apply to Indian companies. But I am trying to highlight just how crucial management quality is.

The management that focuses mostly on meeting analysts' consensus estimates rather than trying to improve the long-term profitability of the company should always be viewed with suspicion. The management's efforts should be directed at all times to improving the fundamentals of the company. For if profitability improves, share prices will follow.

My colleagues Tanushree Banerjee and Richa Agrawal agree. As the managing editors of The India Letter and Hidden Treasure respectively, they often meet company managements. They bring a checklist with them to these meetings...

Is the management more focused on strategies that will help the long-term growth of the business? Or does the management keep a close eye on the company's stock price? This is probably the most important question on the list. If the management seems preoccupied with the price of the stock, they steer clear of the company...and recommend investors to do the same.

Do you think managements should worry about the movement of their company's stock price? Let us know your comments or post them on Equitymaster Club.


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2:38 Chart of the day

Public sector banks remain burdened under the mountain of bad loans. While their poor risk management practices are to be blamed for their present plight, even the law of the land has not been of much help in this case. This is clearly evident in the recent case of Vijay Mallya, who despite being declared as a willful defaulter, has been able to evade punishment. According to RBI, a willful default takes place when the borrower defaults in repaying his loans despite having the capacity to do so, when funds are not utilised for the specific purpose and diverted for other purposes or siphoned off or when the asset bought by the borrowed funds is sold off without the knowledge of the lender.

As per information from Credit Information Bureau of India Ltd (CIBIL), the number of willful defaulters in the country stood at 7,129 as of December 2015. And among the lending institutions, public sector banks top the list. Nationalised banks had a total of 4,705 cases of defaulting entities valued at Rs 392 billion. The country's largest bank, State Bank of India and its associate banks had the second highest number of defaults at 1,546 and valued at Rs 186 billion. In comparison, private sector had 793 cases with an overall value of Rs 102.5 billion.

Banks are required to submit the list of willful defaulters at the end of every quarter to CIBIL. This cuts off any avenues for raising credit by the defaulting entity. The entity is also prevented from floating any new business for a period of five years from the date of being declared a willful defaulter. However, there is no specific law for legal action. Normally banks initiate action against defaulting entities under the SARFAESI (The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act. There is a need for more stringent laws that can act as a deterrent for promoters. SEBI is contemplating to impose capital-raising restrictions on companies that have directors who have served on the boards of companies declared as willful defaulters.

Public Sector Banks Suffer the Most Defaults

3:46

With several parts of the country reeling under severe water shortage, the news of an above normal monsoon in 2016 is already ringing music. As per the Indian Meteorological Department, the monsoon is expected to be above normal at 106% of the Long Period Average. What's more important is that the rainfall would be distributed fairly with a possibility of excess rainfall in some parts of the country. This definitely spells good news for the rural economy that has been hit by lower farm incomes after two consecutive years of insufficient rainfall.

An above-normal monsoon and robust farm output is likely to spur rural spending and aid in overall demand recovery. But the economy still remains vulnerable to the slow pace in the pick-up of investments, low industrial production, sluggish corporate earnings and uncertainty in the reforms process. Even the global volatility arising in the event of Fed raising interest rates can impact markets if FIIs decide to pull out money. Therefore, forecast of good monsoon may have bought the much needed cheer for equity markets, however it continues to face a number of headwinds that can spoil the party.

4:17

22 April 2016 is coming close. By now you know that we will be celebrating our 20th anniversary. It is a time of ruminations and on this occasion we'd love to hear from you. In case you wish to share your experience with Equitymaster or read what some of our valued long time subscribers have to say about us, please do so here.

Here's what Sudhir Vinayak Kubal, an Equitymaster Wealth Alliance Member and a subscriber since 2003 from Dubai, had to say about his experience with Equitymaster:

  • My adventure with equitymaster.com started years back when I was looking for ways to invest my hard earn money in places where it can grow. Knew of few such websites that could help however chose equitymaster.com as my trusted partner. Without any regrets I am glad to say, the site has given my wealth and life a brighter side. Their continuous guidance on trading in the share market as well as sincere amount of time allotted for their client's grievances or concerns makes this site one of the best of its kind.
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4:45

Indian markets traded well above the dotted line in today's trading session buoyed by the optimistic monsoon forecast this year. At the time of writing, BSE Sensex was trading higher by around 440 points. Buying was largely seen in banking, auto, and metals stocks. The BSE Midcap and BSE Smallcap also did well and notched gains of 1% each.

4:55 Today's investment mantra

"We are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

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3 Responses to "I Start Worrying When Promoters Worry About This..."

K Parashivaiah

Apr 15, 2016

I completely agree with the view. It is a very serious issue. If the management is concentrating on short term gimmicks instead of long term fundamentals, one should be skeptical. This kind of window dressing of accounts may be done together with insider trading by the promoters & other persons closely associated. Thanks for throwing light on this simple truth.

Like 

parimal shah

Apr 13, 2016

The management must worry about company and not the stock price.
In fact the stock price would take care of itself if the company is well managed.
Ups and downs in the business are a norm and not exceptions.

Like (1)

Muthuswamy N

Apr 13, 2016

Add to this the reality that the CEO's of US firms get paid also based on the stock prices over the quarter! You have a fail proof recipe for mismanagement of the long term future of the company.

Like (1)
  
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