Stay away from such companies... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Stay away from such companies... 

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In this issue:
» India needs to tone down fiscal deficit
» Buffett will not buy gold even at US$ 800
» Advocate of the Euro now thinks it's a mistake
» India's services sector is contracting
» ...and more!

The importance of good management and ethics of any company should never be undermined. Strong growth in sales and profits and healthy balance sheets are certainly important indicators of how effective the management is in steering the performance of a company. But many a time what tends to get ignored is how critical good corporate governance also is.

Sadly, instances of bad corporate governance practices have only increased in recent times. In India, the Satyam fraud and the 2G scandal are two big examples of the same. But India is not the only one. Globally too in the developed as well as the emerging economies corporate frauds have become more rampant. As a result in the investor community, companies with good corporate governance practices are now being accorded premium valuations.

In this regard, as per an article in the Financial Times, the results published by Ernst & Young's annual fraud survey are quite disconcerting. According to the survey, nearly half of the board members and senior managers of large companies across Europe, the Middle East, Africa and India are aware of irregularities in their own financial reports. This has also highlighted the kind of pressure that companies are facing post the global crisis in a very weak and challenging macro environment. So hell bent are they in maintaining their balance sheets and reporting respectable growth in performance that many of them have taken the easy way out in terms of not giving any thought to ethical practices.

According to us 'pressure in a weak environment' is hardly a reason for the management to ignore irregularities of any kind. Indeed, such companies do not have shareholders' interests in mind and will hardly be value creators in the longer term.

The good thing is that investors have been giving corporate governance the kind of importance it deserves. But this was not always the case before. In the days before the financial meltdown, returns from stocks were probably the only criterion for investing. Sound financial reporting and trustworthy managements which are as important were not given their due consideration. But this has now changed. That is why it is necessary for company managements to understand that taking investors' trust for granted will not take them very far in the long run.

Do you think that companies ignoring irregularities in their businesses can reward shareholders adequately in the long run? Please share your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
As if a burgeoning current account deficit was not enough, India has been struggling to reduce its fiscal deficit as well. And when compared to its peers in this regard, it hardly fares well. Today's chart of the day shows that India is almost on par with the US when the deficit is calculated as a percentage of the Economist's GDP estimate for 2013. The Finance Minister, in his Union Budget speeches, has been highlighting the importance of bringing this under control and has even laid a roadmap for the same. But as of now, the government is finding sticking to the targets quite difficult. Many of the solutions proposed have been more short term in nature. A longer term solution that will address many of India's structural problems will be much more meaningful we believe.

Data Source: The Economist

When it comes to gold, the Oracle of Omaha has his views crystal clear. As per him, the yellow metal is just a relic. It sits there, it earns nothing and is therefore hardly worth anything. Therefore, Mr Buffett is not going to be a gold buyer at any price. Not even if the price collapses to US$ 800 an ounce.

Readers of this space would know that this is one of those rare topics where we disagree with Mr Buffett. Of course, gold does not produce anything and it has no cash flows to measure its intrinsic value against. But according to us, it is the best insurance out there. Insurance against the insane government policies of money printing and currency debasement. Thus, the purpose of holding gold is not to earn income from it. It is to use its perceived value in case the world gets into trouble and stock markets fall and say, the banking system become dysfunctional. As history going back thousands of years shows, the yellow metal can come in real handy during such times.

There are very few instances when you will find the Chinese citizens nodding their heads in agreement with Indians. But owning a home is something that tops the list of aspirations of people on both sides of the Himalayas. Unfortunately this is a dream that has not been easy to realize for either. Housing prices have gone through the roof and made ownership unaffordable to common Indians and Chinese. The slowdown in Chinese economy, like in India, was expected to bring the much needed relied to prospective home buyers. Alas, that hope too has been quashed!

China in particular is facing an unprecedented migration from rural to urban areas. And hence the shortage of housing units is further stoking prices. It is therefore only the richer population that is looking to park surplus funds in second homes to speculate on realty boom. The genuine home buyers are being left out. As per an article in The Economist, the Chinese government and the central bank acknowledge the risk of housing bubble. Like in India, policies have been implemented and taxes have been imposed on high value housing units. Yet, the prices remain beyond the reach of the common buyers. The realty sector in both India and China remain in the grip of developers and speculative investors. Without a correction in prices and availability of affordable homes a social and economic crisis is a given.

All ideas, however great they may seem, have their fair share of critics. But what if the pioneer of an idea realises the faults and turns a critic himself? This is indeed very telling!

What if we were to tell you that the idea in question is none other than the euro currency? An article in Money News makes some interesting revelations. The name may not be familiar. But German finance minister Oskar Lafontaine was one of the strongest advocates of the euro currency. Now, the gentleman has confessed that it was a big mistake. The founders apparently believed that the single currency would force rational economic behaviour across the Eurozone. And this, in turn, would lead to greater economic growth and prosperity. Unfortunately, reality took a different course altogether.

The Eurozone is in a terrible mess with several member nations struggling under the burden of a massive sovereign debt. The response to the crisis has been slow and ineffective with constant differences on policies among member nations. The austerity measures have failed. The economic situation in the region is deteriorating. Unemployment levels are getting worse.

Mr Lafontaine has gone so far as to suggest that the euro currency must be broken up. Else, he believes, it will lead to a massive disaster. We completely agree with the views of the gentleman. But isn't it too late already?

Service sector constitutes approximately 60% to India's Gross Domestic Product (GDP). Thus, it is a lever for India's growth. Contraction in services sector can hurt growth and vice versa. And the news is not good as far as the recent figures on services growth are concerned. The services sector growth has declined for last three months. The HSBC's services purchasing manager's index which is calculated based on survey of 400 odd companies fell to 50.7 last month. It may be noted that the index is right at the cusp of 50 levels which is a defining figure that demarcates growth and contraction. An index level of below 50 depicts contraction and vice versa. The predominant reason for slowdown in services sector is slowdown in overseas markets. Overseas slowdown has meant that discretionary spending has been cut. This has reduced the outsourcing opportunities to India. If the economic environment does not improve in the West then we may well see a contraction in services growth over the next couple of months.

The Indian equity markets continued to move higher into the positive zone as the day progressed. At the time of writing, the BSE-Sensex was trading higher by about 200 points or 1%. Buying activity was witnessed across the board with stocks from the banking, FMCG and realty sectors leading the gains. As for the BSE-Midcap and BSE-Smallcap indices, the same were up by about 0.65% and 0.5% respectively. Stocks markets in rest of Asia ended the day on a firm note with Japan, Hong Kong and China up by 3.5%, 0.6% and 0.2% respectively.

04:56  Today's investing mantra
"Activity is the enemy of investment returns." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Stay away from such companies...". Click here!

    5 Responses to "Stay away from such companies..."

    Ashokkumar B. Kansara

    May 7, 2013

    The financial irregularities ignored/deliberately camoflaged will be revealed in the form of failed growth and reduced profits. Every misdeed caused by unethical practices will take its own toll.
    Certainly the companies having unethical practices can not sustain their existence in the long run and can't serve it's share-holders' interest.


    Satish S Dabholkar

    May 7, 2013

    We should take up the matter with "The Institute of Chartered Accountants of India".The companies whose irregularities come into light after publication of Audited Balance Sheet,The ACA institute should remove the names of such firms who has audited the acounts.We should also held the institute accountable for wrong done by their members.If the institute is not keeping the standard which is expected from it,should stop functioning.


    Maulik Suthar

    May 7, 2013

    Equitymaster is consistently wrong about the Real estate as an investment class.


    krishna murthy

    May 7, 2013

    I strongly believe in ethical values trust & truth and patience of the people at the helm of affairs of the companies. I will not put money in the companies like essar ( Ruia), Raju,s, muthoot or highly speculative companies. I do not want to earn wind fall and not support such people.



    May 7, 2013

    But which are these companies? Please share the names

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