Do you fall for this common management trick? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Do you fall for this common management trick? 

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In this issue:
» Bullish bets on oil outnumber bearish 5:1
» The positive fallout of the Coalgate scandal
» One of the worst decades for US middle class
» Is gold officially money now?
» ...and more!

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We humans have evolved to possess absolutely first rate linguistic skills. Our math skills in comparison look significantly underdeveloped. So much so that most of us come across as useless in something as basic as fractions. An evidence of this is routinely found whenever we go out shopping during the discount season. Imagine being faced with the prospect of choosing between a 50% increase in quantity and 33% discount in price. Most of us could end up choosing the former even though the two offers are exactly the same. Or take the hypothetical example of choosing between a 33% extra free and a 33% drop in price. While on the surface they appear the same, a deeper look would reveal that the discount is a better proposition than the increase in quantity.

If you thought such tactics are adopted by retailers and shopkeepers alone, you are certainly wrong. For even the field of stock investing is known to use this trick and rather generously at that. Take the practice of issuing bonus shares or implementing a stock split. You will routinely hear management talk about how the share price of the company is on the higher side and how doing a stock split will make it more affordable for small investors. Not only this, even stock bonuses are given under the garb of rewarding shareholders for their long term association with the firm.

To make matters worse, investors more often than not fall for this trick and even send the stock price of the company under consideration soaring. What they fail to take into account is the fact that although their number of shares may have gone up, the share price is reduced proportionately. This thus leaves their total investment the same as before. Besides, the management that focuses mostly on bonuses and stock splits rather than trying to improve the long term profitability of the company should always be viewed with suspicion. The management's efforts at all times should be directed at improving the fundamentals of the company. For if profitability improves, share prices will automatically follow. Trying to artificially improve the share price through frequent bonuses and stock splits is not the mark of a good management we believe. And investors should always steer clear of such companies.

Do you think issuing frequent bonuses and doing stock splits is good for investors? Share your views with us or you can also comment on Facebook page / Google+ page.

01:24  Chart of the day
There have been reports doing the rounds that the Indian banking system could potentially be sitting on significantly more NPAs (non performing assets) than those being reported. Today's chart of the day is perhaps one of the key reasons behind the same. As highlighted, the concentration of loans to top corporate groups is the highest for India amongst some of the other countries of the world. This is not to say that most of these loans would eventually turn bad but such a high level of concentration is certainly risky for the long term health of India's banks and efforts should be made to lower the same.

Source: The Economic Times

The middle class usually forms the backbone of any economy. If this bone is hurt, it is a matter of great worry for policymakers. Take the case of the US. Researchers are of the view that America's middle class has witnessed its worst decade in modern history. Wages have been on the decline. A report suggests that since 2001, median household income dropped from US$ 72,956 to US$ 69,487 in 2010. During the same period, median household net worth (value of assets minus debt) declined from US$ 129,582 to US$ 93,150.

Who is responsible for such a massive destruction of wealth? The American middle class points the finger on US lawmakers, banks and big corporates. We totally subscribe to this view. India must learn from the mistakes of the US. If at all such a crisis were to hit India, the consequences would be far worse. This is because we have a much larger population. Moreover, the existing standards of living are abysmal compared to the US. It will be best if Indian policymakers can get over their petty politics and think about the long term interests of the country.

Betting on oil prices has burnt many a fingers in the past. However, that hardly deters speculators to leave them to fundamentals. Presently, the bullish bets on oil outnumber bearish ones by 5:1. From the view point of bears, oil prices are likely to fall due to weak global economic growth along with a higher production from Saudi Arabia and non OPEC nations. The reasons are realistic and convincing. In contrast, the key events that oil bulls are betting on are Iran going to war and hope of a global economic revival; both of which look unlikely. With 80% of Iran's GDP hinging on oil, its chances of striking back and risking its own foundation are remote. The entire issue has been in the news for a long time now and has already been factored in oil prices.

As most of the variables suggest a fall in the oil prices in the future, we believe downslide (when happens) will be steep, reminding that majority is not always right, especially with a commodity as slippery as oil.

Flash back to the 1970s. President of US, Richard Nixon decided to end the gold standard. Since then, nearly every nation followed suit and delinked their currency from gold. The result, though countries continued to hold gold as reserves, it was no longer treated as a form of money. However, because of being a natural hedge to inflation, the yellow metal continued to enjoy the safe haven status. Fast forward to present day. This safe haven status has helped it regain its status as money again. The recent letter issued by the US Federal Reserve on Basel III has helped gold get this distinction.

The letter states that gold is now a part of the zero percent risk weighted items. This means that now banks can count the value of their gold reserves as a part of their Tier I capital. Gold is just a notch below cash which is the paper currency in terms of being regarded as risk free. Therefore banks may now look at increasing their holdings in gold. This in turn would lead to an increase in demand for the precious metal and a consequent increase in its prices. For those investors who hold gold as a part of their portfolio, it is time to rejoice as their portfolio values are set to increase. For those who don't, it may be time to trust the metal again and invest some part of their money in the same.

Mining reforms in India have been long desired. For an economy with limited natural resources and spiralling demand from growing industries, reforms are a must. Only then can be a seamless supply of resources to fuel the economy's needs. Energy in particular is the backbone of a growing economy. Hence policies facilitating the growth of this sector have to be the government's priority.

Unfortunately in India, the government was sleeping over coal mining reforms for ages. This is despite the fact that India depends on coal for near two third of its power supply. The PSU behemoth in this space, Coal India, was only too happy enjoying its monopoly all these years. It had little incentive to improve production and efficiency levels. And even when the power generators declared grand expansion plans, little was done to product more coal. Even if that meant having a huge gap with respect to 5 year plan targets.

It took a massive mining scam and some scathing reports from the Comptroller and Auditor General (CAG) to wake the government from its slumber. The opposition is in no mood to let go of this golden opportunity. Hence, the incumbent government may have to finally complete its long pending task.

Meanwhile, indices in the equity market in India are trading buoyant yet again today with the Sensex higher by around 90 points at the time of writing. IT and metal counters seem to be the most in demand. While most Asian stock markets closed strong today, Europe too has opened on a positive note.

04:52  Today's investing mantra
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett

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    5 Responses to "Do you fall for this common management trick?"

    sunilkumar tejwani

    Aug 25, 2012

    it does distort the price mechanism in the short term. But eventually it is the fundamentals of a company which should be considered before investing.



    Aug 24, 2012

    It help in artifical short term loss ( if bought within a year) and helps exiting partially if the current is right. not really good for those who hold for long term technically.



    Aug 23, 2012

    Can it be clrified with some examples? If I look at the issue of split/bonus of companies like Infosys, ONGC the bonus and/or split added to the value of the portfolio in the long run.


    manoj ahuja

    Aug 23, 2012

    The bonus stocks are issued to nullify the amounts lying in Reserves and surplus A/c.With this the share capital increases and Reserves and Surplus a/c goes down. The net effect is same, but the market does not value a share price on basis of company's reserves and surplus. You may find many companies, whose book value is higher, but stock prices are lower than 50%, therefore to capitalise on this aspect, bonuses are issued.



    Aug 23, 2012

    This is with respect to Bonus or Split shares:
    The basic premise of bonus shares or split shares is to reduce the price per share and thus making it more liquid or priced affordable. The built-in purpose of this exercise is to entertain small investors also to ventunre into buying. This can be equated (not exactly same) Shampoo sachet vs Shampoo bottle. The basic price per unit of shampoo (say paise per ml) would be almost same for both. But the Shampoo sachet is affordable to poor folks than the bottle of shampoo. This simple strategy is expected to widen the cusumer base, driving the sales up leading to increased revenue.
    However, as you've observed, the motto of a bonus share or split should not be to divert the attention to the business needs or challenges.

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