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The Importance of Corporate Role Models

Sep 6, 2016

In this issue:
» All is Not Lost for The Indian Startup Industry
» Urjit Patel Takes Charge as the Governor of the Reserve Bank of India
» ...and more!
00:00
Rohan Pinto, Research analyst

Rahul Shah, Equitymaster Co-Head of Research, has this great heuristic he uses to judge a person's character. The heuristic, inspired by Warren Buffett, might not be perfect, but it is highly effective.

Often during research meetings, Rahul unleashes this question on the managers and promoters: Who do you consider a role model in your industry?

'Tell me who are your role models, and I will tell you what type of person you are,' says Rahul.

Well, say the promoter enthusiastically replies, 'Enron!'

Rahul would politely shake hands, end the meet with a smile, and promptly cross that company off our list of potential recommendations.

Now, management quality is often ignored since it does not involve a simple quantifiable metric that can indicate a potentially disastrous investment.

  • In looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don't have the first, the other two will kill you. - Warren Buffett

That's why Richa Agarwal travels the length and the breadth of the country in her search for outstanding investments. And everywhere she goes, accompanying Richa is a comprehensive checklist she uses to judge management quality.

Some of Richa's questions make the management uncomfortable, but she believes it is her duty as an analyst and managing editor to ask them. For example, if any of the management's answers imply they are preoccupied with the price of the stock, she steers clear of the company...

Remember, however small the stake might be, a stock purchase represents ownership in a business. The minority shareholders, however, are often ignored by promoters who run the organisation with selfish motives and vested interests.

It is thus imperative to find promoters and managements who treat minority shareholders as they would larger shareholders.

What traits define an ideal management?

For us, the management has to satisfactorily meet the below criteria to be considered a potential investment:

  1. Does not look to increase revenues with disregard for profitability
  2. Respects capital and employs capital judiciously
  3. Understands the cost of equity (i.e. dilution) is more than the cost of debt
  4. Knows debt has onerous covenants that can destroy the company
  5. Is willing to undergo pain in the short run for returns in the long run

The list isn't exhaustive...

The takeaway from all this is the vital importance of the 'people' side of the organisation. The people actively running the company behind the scenes will play a big role in the returns you earn.

The promoter of a company on our Hidden Treasure list is, dare we say, a role model for corporate India. In addition to his shrewd management, he has voluntarily waved his well-derserved commissions and only takes home a modest fixed salary. Click here to know more about this company.



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------------------------------

03:10 Chart of the Day

India's startup boom seems to be slowing down. We have written about this before. But now there are numbers available in the public domain. We are all aware of the woes of the likes of Flipkart. Many other consumer centric startups have failed Tiny owl certainly comes to mind.

Now, as an article in The Financial Express has highlighted, the pain has spread to the B2B space. According to Tracxn, funds invested in these players have fallen by over 50% YoY. Some like Intelligent Interfaces and Townrush, have been forced to shut down. This despite the fact that B2B players have better business models that B2C firms.

B2B Start-ups Are Still Receiving Funding


This trend highlights the extent to which VC funding has driven Indian startups. Many of these firms had nothing unique to distinguish themselves. When the funding dried up, the growth came to a halt.

However, all is not lost. B2B startups that have a viable business are still getting funding. We believe, this is a healthy sign for the future of Indian startups.

03:50

Urjit Patel has taken charge as the governor of the Reserve Bank of India. The economic situation is very different compared to the time when Raghuram Rajan took over. Three years ago, the Rupee was in a free fall, governance was paralysed, the stock market was despondent, and India was part of the 'fragile five'.

Raghuram Rajan has certainly done his bit to turn things around. He has passed on the baton to RBI veteran Urjit Patel. But just because things are sanguine today, doesn't mean all is well. He has his task cut out.

Commodity prices have slowly but surely begun rising. Along with it, consumer inflation is on the rise. The RBI has an inflation target of 4% to achieve. It must maintain the CPI between 2% and 6%. Markets perceive Dr Patel to be hawkish on inflation, just like Rajan. But the important thing to keep in mind is that he won't be setting interest rates himself.

At the next monetary policy meet, decision on interest rates will be taken by a committee. This hasn't been formed yet. As we have stated before, Dr Patel will have to walk a fine line to satisfy the call for a rate cut by the government and the common man's desire for low inflation.

Vivek Kaul has written an excellent article covering the various challenges before the new governor. In case you missed it, you can read it here.

04:30

After opening the day on a strong note, the Indian stock markets continued to trade above the dotted line. At the time of writing, the BSE-Sensex was trading up by about 293 points while the NSE Nifty was trading up by 88 points. The gains were primarily seen in banking, auto and consumer durables' sectors.

04:50 Today's Investing Mantra

"It's better to hang out with people better than you. Pick out associates whose behavior is better than yours and you'll drift in that direction." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rohan Pinto (Research Analyst).

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Equitymaster requests your view! Post a comment on "The Importance of Corporate Role Models". Click here!

1 Responses to "The Importance of Corporate Role Models"

DKapur

Sep 14, 2016

In your traits of the ideal management, the Integrity piece is missing. You quote Warren Buffet and miss out on including Integrity which is the first thing he looks at.

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Equitymaster requests your view! Post a comment on "The Importance of Corporate Role Models". Click here!
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