When CEOs turn analysts... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

When CEOs turn analysts... 

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In this issue:
» One global CEO gets a pay cut for missing guidance!
» Capacity utilization suffers across many key sectors..
» Will we ever have an Indian Alibaba?
» Countries most vulnerable to Chinese slowdown...
» ...and more!

"We plan to double our market capitalization in 3-4 years" said one Chairman of a noted listed public entity in a recently concluded AGM. Though we did not attend the AGM as we are not the shareholders, we came across the extract in one of the leading news daily. And it grabbed our attention pretty soon. For its sheer optimism over a matter (read market cap) which can distract gullible investors.

We understand that management is here to guide the analyst community. They know more about the business than outside people. Hence, forward looking statements are expected from them. In fact, we, at Equitymaster, lay special effort in reaching out to every company that we recommend to know more about their business. However, management guidance in the Indian context has become more of a mass marketing tool to hard sell the company. Failing to meet the same has little or no repercussions.

Contrast this with what happens elsewhere. As you will see later in one of the stories below, one CEO in the US had to take a pay cut after he failed to meet the targets it set for itself! More about it, later. For the time being, let us just focus on the Indian Chairman's declaration to double its market capitalization.

To be quite honest, we were a bit surprised by such a forward looking statement. For one, doubling market cap is not in management's hand. True, that management's actions help drive market cap. But the true role of any promoter is to guide about the business and not market cap. Such statements are just made to create investor interest in the stock. But when they come from a business house of repute, it amuses us.

This carries a very important lesson for investors. Do not take the management on face value. Also, one has to be equipped to weed out unnecessary information that comes out from management as was the case here.

The bottomline is that one has to do his own checks and balances while investing in any stock. And not rely on management commentary alone. Also, one should bear in mind that no management is ever going to be upfront in saying WE ARE IN TROUBLE with a few exceptions. Ask Vijay Mallya about Kingfisher's growth prospects and he would still be bullish about it.

Smart investors are ideally people who look for signals that indicate where the company is headed. Management commentary is just used as a tool in getting those signals. Blindly believing in the management or the analyst community whose ratings are fraught with conflict of interest is a recipe for disaster. Remember, the Reliance power IPO?!

Do you watch out for management claims while making your investment decision? Let us know your comments or share your views in the Equitymaster Club.

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Arguable the best way to prove that a company is fair and transparent in its dealings with all the stakeholders is to take responsibility right at the top. And Cisco, the US based IT giant seems to have done just that. As per reports, the firm has cut the pay of its CEO by a significant 22% as it failed to meet its revenue and profit targets. Even though the shortfall hasn't been all that noteworthy, the reduction in CEO pay does set the right example we believe. Not just that, Cisco's other senior executives also bore the brunt of a pay cut due to the same reasons. Now this is what a good corporate governance policy should be all about according to us. After all, the same CEO who's paid handsomely when a company does well cannot escape a paycut when it fails to meet the targets.

Unfortunately, this is more of an exception than the norm. There are several instances of firms doling out one pay rise after the other for the CEO irrespective of how the firm is performing. As Warren Buffett says, even a dormant savings account can generate more income simply by adding more capital. The real test of a CEO lies in not only enabling the firm to grow but also ensure that it adds to shareholder value. Failing the same, the CEO does needs to be penalised we believe.

02:30  Chart of the day
There was a time when China was looked up to for its spectacular economic growth rate. However, things have changed for the worse over the last few years for this economy. And the slowdown in China is likely to create a ripple effect, thus disturbing other economies as well. The extent of damage will depend upon the level of exposure of these economies to China. As per the data collated by Barclays Research, South Korea is likely to be one of the worst victims. One must note that China alone accounts for 31% of its exports. Other economies likely to be severely hit will be Taiwan that gets 28% export revenues from China.

That things are pretty shaky for China is a matter of concern, considering the global economic coupling. However, things don't seem that grim for India in this regard. As the chart indicates, India's export exposure to China is the lowest at 5%. That's quite a relief as Indian economy itself has started witnessing green shoots only recently. As the major reforms and structural changes are yet to be implemented, the last thing it needs is other economies slowing it down.

Nations most vulnerable to Chinese slowdown
SK= South Korea

There is little doubt about the fact that India's economic parameters are set to improve sooner than later. However, the question on investor minds is that how soon will that happen. More importantly, whether they can pocket some quick riches? Well, going by the past trends of economic resurgence, things do not change overnight. And it is not going to be very different for India. A certain and positive change is in the making. However, investors will have to be patient to witness the economic change impacting corporate profits.

Take the case of capacity utilization in select industries. As per an article in Mint, capacity utilization in sectors such as automobiles, cement and steel is nearly at a decade low. Hence it will be sometime before these sectors plan additional capex. Well, whether capex or not, the fact that the companies have sufficient capacity to cater to higher growth in demand will automatically boost their volumes. In fact, without the burden of capex, the revenue from incremental volumes will directly add to profits and shareholder returns in the coming years. Thus, while capex could be restricted to non cyclical sectors, the possibility of better corporate performance is real for most businesses that are set to ride the Megatrend.

The recent blockbuster IPO of Chinese e-commerce giant Alibaba is the buzzword in the financial media these days. Why wouldn't it be? Its market capitalization now exceeds that of Amazon and E-bay put together. And every big story from our neighbour nudges us for a parallel back home, almost compulsively.

So, will India have its Alibaba? When? Who will it be? As per one of the Bansal brothers who have founded the leading Indian e-commerce portal Flipkart, it could be as close as 5 years from now. And the combined entity Flipkart-Myntra (Flipkart has acquired Myntra) is working towards that. Flipkart-Myntra currently controls an estimated 50% of the Indian e-commerce market. Bansal said that India could have one or more US$ 100 bn internet companies by about 2020.

Well, there is no doubt that e-commerce is the next big thing in India given the rapidly increasing mobile internet penetration. So growth is certainly not a question. But growth is not the only investment criterion. From an investor's point of view, it is "profitable" growth that matters. Even the American e-commerce giant Amazon has been barely profitable. So it is a long way before the e-commerce industry proves to be a sustainably profitable business model. Until then, we would like to keep away from all the hype surrounding the next Indian Alibaba.

In the meanwhile, the Indian stock markets slipped further in the post noon trading session. At the time of writing, BSE-Sensex was trading lower by 59 points (0.2%). Barring IT and power, all the sectoral indices were trading in red with energy and FMCG stocks witnessing the maximum selling pressure. Most of the Asian equity markets were trading in the red with Hong Kong and Korea being the biggest losers. However, the Chinese index was trading in the green. European markets have opened the day on a mixed note.

04:56  Today's investing mantra
"We enjoy the process far more than the proceeds." - Warren Buffett

Editor's note: There will be no issue of The 5 Minute Wrapup on 2nd and 3rd October 2014 due to Mahatma Gandhi Jayanti and Dassera respectively.
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1 Responses to "When CEOs turn analysts..."

Sonu Patel

Oct 1, 2014

If promoter wants to be rich, as a equity investor you wants to become rich. Find out which company promoters wants to be rich by law binding method, join the wagon. Very simple and needs common sense.

Equitymaster requests your view! Post a comment on "When CEOs turn analysts...". Click here!


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