The biggest danger to stocks from star CEOs - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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The biggest danger to stocks from star CEOs 

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In this issue:
» Planning Commission's candid confession on FY12 GDP
» Indians amongst worst affected by price rises
» A possible solution to India's land acquisition problems
» Chinese banks to seek massive capital doses
» ...and more!


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00:00
 
A 10% single day crash in the prices of one of the country's most revered blue chip stock is not commonplace. Most unexpectedly, such a scenario played out for Infosys yesterday. Investors freaked out at the thought of massive loss in the company's market value. And warnings of earnings downgrade from brokers only added to the panic on the streets. Given the high expectations built up by bluechips as these, the followers of quarterly EPS estimates often encounter disappointments. In fact this is not the first time Infosys was subject to market fury. Way back in April 2003 a lower than estimated earnings performance had caused the stock to fall by a massive 27% in a single day. But yesterday's panic had more to it than the fear of lower earnings.

The exit of Mr. Mohandas Pai from the company took away from Infosys the prospects of being governed by a 'star CEO'. We call it so because of the extra premiums that stocks command due to the star value of their CEOs. And Infosys is not the only example of such a company. The stocks of companies like Apple and Tata Motors have also come to command a similar status thanks to Steve Jobs and Ratan Tata (chairman) respectively. Precisely why Mr Jobs' health and Mr Tata's succession planning are of as much concern to the markets as their companies' earnings prospects. We believe that betting on such aspects is equal to throwing a dart for stock picking.

While we are strong believers of management quality we prefer to stick to Buffett's maxim in this regard for stock picking. "You should invest in a business that even a fool can run, because probably someday a fool will." With due regards to the companies with star CEOs, we believe that their long term fortunes should be judged by investors keeping ordinary managers in mind. And if you look around, you will find yourself ignorant about the CEOs of some of the biggest wealth creating companies globally. This is proof enough that star CEO premiums could be the biggest danger in stock valuation.

Do you believe in valuing stocks based on the companies' star CEOs? Let us know your views or post them on our facebook page.

01:20  Chart of the day
 
Emerging economies are already feeling the heat of rising price levels on their growth prospects. The developed ones are swallowing the threat of hyper inflation like a slow poison. But none can deny the gloomy prospects if food and oil prices go beyond control. Interestingly a look at the consumer inflation numbers over the past five years shows that Indians are amongst the worst affected. India tops the BRIC nations in terms of rise in prices at the consumers' level over the past 5 years. Little wonder then that there has been a massive rise in below poverty line (BPL) population in the country.

Data source: Tradingeconomics

01:55
 
Sticking to the topic of inflation, the malaise continues to cause big headaches to the Indian government. Although the RBI resorted to raising rates 8 times in FY11, inflation has not yet eased off within the comfort limits of the central bank. The headline inflation rose to 8.98% in March from 8.31% in February 2011. As a result of this, the Planning Commission has raised doubts over clocking the targeted 9% economic growth in the current fiscal i.e. FY12. Deputy Chairman of the Commission Mr. Montek Singh Ahluwalia has also raised concerns with respect to the growth in agriculture. He opines that it will be difficult for the agricultural sector to clock a growth of 6% and that it is likely to grow at a lukewarm 3% instead.

Indeed, persistent inflation has made things difficult for the central bank which now seems at its wits' end. The tools for hiking rates seem to have not done much so far. The impact of this will be felt by India Inc., which is already reeling under the burden of high input costs. A rise in interest rates will only put that much more pressure on their financials and eat into profits. This is the time for the government to put some long term measures in place that will ensure no supply side constraints in the future and thereby put the lid on inflation.

02:35
 
Yesterday's wrap up covered a story about how land acquisition is proving to be the bottleneck-in-chief for the slow pace of infrastructure development in India. Indeed, it has been so many years since independence. And still, Government does not seem to have run into a solution to this problem. Fortunately for us, there exists a state in India that has never seen an agitation over land acquisition. The state answers to the name of Punjab. It would be interesting to see what magic pill has this state stumbled upon that it has found the answer to a problem plaguing the country for so long. As per a leading daily, Punjab strongly believes in the theory that what matters is the size of the compensation. And sticking to this same theory, the state has gone to great lengths to set new benchmarks in land prices. Furthermore, it has not been averse to paying much higher compensation than even the prevailing market value in all recent land acquisitions.

Will replicating the Punjab model in all the other states do the trick there as well? We believe that rather than copying the Punjab model blindly, an attempt should be made to study the philosophy at work here. By paying more than market prices, Punjab is giving the impression that it has the best interest of the sellers in mind. It is removing the doubts from the minds of people that it is an agent of the corporate world. We believe that this is the trust that all the Governments should help create in the minds of sellers. And if this is achieved, then we would have taken a big step towards the objective so desired.

03:25
 
It seems that China is done with its obsession for high GDP growth. The concern is now shifting to rein in the fast credit growth to keep economy on an even keel. As high prices in the economy show their teeth, the banks in China may get a wakeup call. The top Chinese banks are already required to meet a minimum capital ratio of 11.5%. But this has not been enough to keep inflation in control that has now become a major political concern. The Government has made moves like raising capital adequacy ratios and has also raised reserve ratio six times in last six months. To meet these standards, the Chinese banks may have to raise US$ 131 bn in equity over 6 years. And this might not be enough. The banks may need to add further capital of US$ 193 bn by end of 2016. The estimates assume an economic growth of 8% and 15% credit growth.

Still healing from the economic crisis led by huge lending boom and by high rates of inflation, all we can say is better late than never. The money and inflation numbers for China do deserve a keen watch, even more than the GDP ones.

04:15
 
After three consecutive weeks of gains, the rally in global stock markets finally came to a halt this week. All global indices closed the week in the red with the exception of China. Russia and Brazil were amongst the biggest losers for the week. Nevertheless, the US and the Indian stock market registered modest losses of 0.3% and were relatively flat during the week.

The US markets ended the week on a flat note (-0.3% WoW) as concerns over upcoming earnings season clouded investor sentiments. They also overlooked the positive set of economic news reported during the week. The core-inflation figure in the US was below expectations while the consumer sentiment index was above expectations. However, earnings concerns overweighed the positive economic data. Even the Indian stock markets closed the week on relatively flat note as disappointing results from IT bellwether Infosys and higher than expected inflation figure for the month of March dented investor sentiments.

Data source: Yahoo Finance, Kitco

04:45  Weekend investing mantra
"The investor of today does not profit from yesterday's growth." - Warren Buffett
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11 Responses to "The biggest danger to stocks from star CEOs"

Nirav Mehta

Apr 19, 2011

Well, there has to be a balanced view of the argument on 'STAR CEO'

Whist I agree that what should be looked at his how the middle management is working in the company and how it is managing the actual ground functioning, it is also equally important for someone to give them vision & mission to work towards.

This can be served by a diverse, well experienced borad of management (Note: I am not using the word Directors), which can serve the purpose and at the same time doing away with the need to have a star CEO

Like 

Lalit Kumar Pahwa

Apr 18, 2011

While conceptually I agree with Warren Buffet's approach, however, one should not shun a company just because it has a star CEO. In today's media frenzy, we need to recognise whether the 'star'is a media creation or handiwork of the company's PR deptt or is he a genuine performer and star. How would you react to making investment in Berkershire Hathaway - after Buffet is gone !! Stars have their value much like a brand that the company has. These have large intangible values, but reflect in the share prices in a tangible way - which is the way it should be.

Like 

C F Joseph

Apr 17, 2011

The companies which are run by individual dynamics have the danger of drifting as and when the star performer moves.

I believe, one should develop system oriented and systems driven organization. The organization should not be depending on the CEO/COO to be a star organization.

Only companies that have board members who are non-corrupt and with no vested interests, will be able to steer the organization on the right path....

Thus investors should look into the soundness of the business model and a little bit on the character and past history of the Promoters...

Regards,
Joseph

Like 

S.K.Damani

Apr 16, 2011

Star CEO's might be the risk to valuation, but till such time they are at the helm, we investors are safe.Legends like JRD, Narayan Murthy and Dhirubhai are one in billions.
Ratan Tata and now Pai instill confidence in the investors that they will not be swindled. Even between the two Brothers people have more confidence in Mukeshbhai than Anil.
Thanks SKD.

Like 

v.v.rao

Apr 16, 2011

It will be a futile effort of raising interest rates to control inflation. Given the circumstances and more disposable income of recently incresed salaries of employess, the inflation is bound to increase due to incrased demand on commodities. The government should encourage more savings instead of increasing the interest rates by allowing more eemptions on saving limits on tax thus increasing the savings. This will facilitate more savings instead of spending. At least the tax exemption limit should be raised to further one lakh. The individuals should be allowed certain percentage of their earnings withouttax. This limit should be raised. secondly, there must be an increase in exemption on principle and interest for home loans of low and middle income groups. This will help in indirectly reducing the inflation rate by increasing the savings rate of the citizens. These measures will take care of the demand side of inflation.

Finally, to overcome the supply side bottlenecks, the government should make a sweeping changes in the policies in addressing the agriculture and farm sector which encourage more agri and food processing sectors.
Indian corporate sector should be allowed to enter into some sort of contract and co-operative farming with farmers so that the both natural and human resourses should be utilized in a proper mannar.

Finally, the government should make changes in the Rural employment guarantee scheme so that the labour shortage will be reduced. There must be a single source of supplying labour to agricultural and other farma activities so that idle manmopower need not be fed with government schemes. This paid idle manpower situation should be avoided to save the government funds.

Like 

J.Theeyarath

Apr 16, 2011

It is no surprise, though shocking, that the price rise in consumer index is highest among BRIC countries during the last 05 years. And it has not only increased the number living BPL even those living above BPL feels the severe pain and not any more pinching. Still our FM feels that taming inflation will have to be at the expense of growth!! Again, prices go up due to two reasons. Reason #1, when there is no supply to meet the demand. Reason #2, there is enough invisible money in the market to absorb all that comes to the market quickly like a blotting paper. Once these two issues combine it takes the terrible figure of a demon!!
Our country is already into it nose deep and the demon, the real villain is the black money which is floating around un abashedly!! The political parties have made it a point to amass black money with the sole purpose winning elections. Once in power thecreate and amass more and more of it with the ulterior aim of buying the votes when elections come. And this is a vicious circle which will go on until the NATION IS ENGULFED by it like SUNAMI!!
Can any amount of liquidity control by RBI make a even a scratch, not dent, in controlling the INFLATION DEMON, under the circumstances!!
CORRUPTION leads to BLACK MONEY leads to INFLATION
Indirectly therefore, unless the people are corrupt there cannot be GROWTH! At best,that is how we can interpret our FMs recent statement!! Do, our panel of high level planners also agree with FM then GOD save the nation!!

Like 

sunilkumar tejwani

Apr 16, 2011

yesterday's market action has clearly shown that the fall was led by three I.T stocks, namely Infosys, Wipro & to somewhat extent TCS, not the entire market collapse. In fact, other stocks more or less remained steady, & many mid & small cap stocks gained ranging from 2 to 10%
This proves one point: that the markets are mature, & a few heavy weights which are purely meant for Nifty manipulation, create volatility, huge built up in Nifty F&O has always generated such scenario.

Like 

sunilkumar tejwani

Apr 16, 2011

To my mind Indian IT sector (the top three) have always commanded crazy valuations during bull runs. Their dividend yield is abysmally low & a high PE makes them a risky bet during bull runs. They are best bought around 15-16 PE multiple & sold off around 28-32 PE multiple, which is what happened with Infosys yesterday. Since many months Infosys has been trading at rich valuations, &a steep fall was bound to happen for some or the other reason.
Blame it on big speculators from across the globe: read ADR speculators or U.S. institutional money influx, which had propelled the stock to dizzying valuations. And now the same money has been withdrawn yesterday from the stock.

Like 

R.Chandrasekaran

Apr 16, 2011

Star powers may be known to most of the population for a longer time, but same company should and might have still more bright power who are not exposed to maintain the existing Star value, but mostly all the stars use to have some moving forces behind them.They are real pillars,but those pillars to create again some strong pillars provided the copany really very much on the growth. so the star depends on company but not the company depends on star, star may be a valued one for a sick company.

Like 

R.Manthramurthy

Apr 16, 2011

I agree with Buffet's maxim in this regard. We should not place undue importance on CEOs in a professionally managed company. "If not this man another will run the show" should be the expectation of investors. Mr.Mohandas Pai is not indispensablt to Infosys. Without Nilekani it was run smoothly. So with the impending exit of Narayan Murthy. Is not mr.Azim Premji, a non technical man runnig Wipro efficiently?

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