Sell the stock if a CEO talks like this...

Oct 19, 2012

In this issue:
» How does gold correlate with global assets?
» TCI takes its fight against Coal India to new heights
» The ghosts of the Satyam scam
» Europe has bigger problems than the debt crisis
» ...and more!

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The presidential elections of the world's economic and military superpower, the United States of America, are less than a month away. Prior to the elections, it is customary for the main candidates of the two largest political parties to engage in a series of debates. Something very intriguing happened during the second debate between incumbent Democrat party President Barack Obama and Republican candidate Mitt Romney.

The story goes thus. During the debate, moderator Candy Crowley asked whether Mr Romney would be willing to reconsider his 20% tax cut plan in case his budget numbers don't add up. It must be noted here that the Republican candidate has made some big promises with his bold budget plans. What should have been his answer according to you? Ideally, he should have just explained the math, right?

But Mr Romney didn't do exactly that. His immediate response was this-"Well of course they add up. I was someone who ran businesses for 25 years and balanced the budget. I ran the Olympics and balanced the budget. I ran the state of Massachusetts as a governor... and balanced the budget all four years." He then went on criticising the budget deficits created by the Obama administrations over the last four years.

Now, chances are Mr Romney could actually be right. Since he has managed budgets well in the past, there is a possibility he could do it again. The point of contention here is not whether he could repeat the feat. But the thing is that if you are running for the President of a country, such vague answers with a tinge of overconfidence are not a positive sign.

Let us tell you that we are not here to speculate who the next US President will be. But we believe that investors have a very pertinent lesson to learn from this episode. CEOs are like Presidents. While investing in stocks, do not ignore the quality of the management. Pay attention to what they say and do not say. Don't get carried away by their big plans if not backed with logic and numbers. If they keep harping about their past achievements without laying out a clear road for the future, treat it as an ominous sign. Either it means the success has gotten into their head and they find it offensive when somebody asks for explanations. Or maybe they themselves do not know what they're heading towards. Or worse, maybe there is something suspicious.

On the other hand, CEOs who run great businesses are open to questions and often more than willing to explain their positions. Legendary investor Warren Buffett is a great example. He is known for his candid discussions with the shareholders of Berkshire Hathaway. In fact, his letters to shareholders are keenly studied by investors across the world.

Which Indian CEOs do you admire and why? Share your views or you can also comment on Facebook page / Google+ page

 Chart of the day
In our yesterday's 5 Minute Wrapup edition, we had discussed how gold prices have a strong correlation with US monetary base. Today's chart of the day shows gold's long term correlation with other global assets such as global bonds, commodities, emerging markets, global equities and US dollar index. It is evident that over the long term, gold has a low correlation with these asset classes. As such, investing a part of your portfolio in gold helps an investor in reducing the portfolio risk.

Data source: Business Insider
*Correlation calculated using period between December 1987 and September 2012.

The Indian government is known to treat PSU entities like its own backyard. What with subsidies, cheap loans and resources at throwaway prices being given out through them? Needless to say that decisions for Coal India (CIL) were least contemplated with minority shareholders in mind. Especially since the government still holds 90% stake in the mining behemoth. But it seems a foreign shareholder with barely 1% stake is set to give the government a run for its power. A London based hedge fund by the name The Children's Investment Fund (TCI) has taken its legal battle against the management of Coal India to new heights. So much so that it will now have the status of class action suit.

In its complaint, TCI has claimed Rs 2.1 trillion from the government of India on behalf of CIL shareholders. This is the compensation it has sought for losses caused by its policy to price coal substantially below market prices. The loss is estimated for a period starting November 2010 to March 2013, for 861 m tonnes of coal sales under fuel-supply agreements. That too at a price differential of Rs 2,500 a tonne. TCI is also seeking interest on this sum at prevailing commercial rates of 18% per annum. Whether or not TCI's appeal is upheld in the court of law, the case will certainly teach the government to take the interest of minority shareholders of PSUs more seriously.

The Satyam scam had rocked the Indian industry a few years back. The company's CEO had confessed to fudging its accounts. In 2009, the beleaguered company was taken over by Tech Mahindra and rechristened Mahindra Satyam. Ever since then, the new promoters worked hard to extinguish all the black marks of the scam. The company had conducted a forensic audit to establish all contingent and outstanding liabilities. Part of this was the 'suspense accounts' of Rs 23.7 bn related to 'unexplained differences and 'amounts pending investigation'. The Enforcement Directorate (ED) appears to have solved the mystery related to the first account of unexplained difference. It has taken control of Rs 8.22 bn of cash which it feels is related to the scam. This amount is related to the amount raised by the ex-CEO through pledging of Satyam's shares under false pretexts.

Since Mahindra Satyam had prudently labeled this cash as a part of the suspense account, it would really not suffer any bad blood on account of this attachment by the ED. The bottom line here is not the amount involved or how it was attached. It is following prudent corporate governance practice. Acknowledging a mistake and taking corrective action is what is important. And at the same time being open about it is what matters. Hiding things or circumventing the issue does not help the company or its investors in the long run.

We think it was the former British Prime Minister Churchill who once said that democracy is the worst form of Government except all the others that have been tried. Certainly. Given how vastly different all of our thought processes are, there can never be near unanimous consensus on any issue we believe. But a democratic system does ensure that all the voices are heard and the best possible solution is found. In view of this, a lot of people are surprised that democracy is facing an acute challenge in the EU region. In fact, many are calling it a bigger crisis than the region's tryst with sovereign debt. And come to think of it, the European Union has only recently been awarded the Nobel Peace prize. And for what purpose? Well, for fostering democracy in the region.

But why is democracy under threat in the EU in the first place? While we are no political experts, we believe that the freedom that Governments have in each of the EU member countries, is fast being transferred to the EU commission. And since the commission is a non-elected body, such a move is not in keeping with the democratic tradition. Will this hurt the long term interests of the region? We think so, for citizens across will have no choice but put up with all the rules enacted by the EU commission. Even if they do not believe in it. Worse still, they will also not be able to use the power of their ballot to force a change. Not a very good state of affairs we should say.

The last many years has seen interest in China surge. Not only has the dragon nation grown at a stupendous pace before the global crisis, but even in the aftermath of the crisis, leaders have banked upon this country to rebalance the global economy. Not all things have gone as per plan. There were serious concerns about property prices bloating in the country leading to the formation of asset bubbles. This led the government to tighten monetary policy. And a slowdown has begun to be felt in the country as a prolonged recession in the developed world has persisted.

In such a situation what is Jim Rogers' take on China? He maintains that China will continue its process of opening up its economy. He believes that China has done a good job of trying to cool down things over last 3 years. However, he does not think the central bank's policy of gradually loosening things again is the right step until the problem of inflation and real estate bubble is completely cured. However, Rogers opines that the biggest problem for China going forward is inadequate water. He believes the country's water problems are serious and while other problems can be dealt over time, this issue can be a deal breaker.

In the meanwhile, the Indian equity markets hovered in the negative territory today. At the time of writing, BSE Sensex was down by 110 points (0.6%). Barring consumer durables and IT stocks, all sectoral indices witnessed losses. Asian stock markets traded mixed with Malaysia as the top gainer and South Korea as the top loser.

 Today's Investing Mantra
"If they don't have integrity, they never will. The chains of habit are sometimes too heavy to be broken." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Sell the stock if a CEO talks like this...". Click here!

    3 Responses to "Sell the stock if a CEO talks like this..."


    Oct 19, 2012

    Mitt Romney gave the right reply drawing attention to his successful track record. Had he fallen in the trap and said he would reconsider tax cuts of numbers did not add up he would ave been accused of not being sure of himself!

    TCI deserves praise for standing up for the rights of its investors - minority share holders - against the unlawful bullying by GOI. Swaraj Paul had shaken Indian Industrialists when he had bought shares of Escorts, DCM etc that were run as personal fiefdom of promotors. There was no corporate governance in Indian Companies except TATAS and a few others those days. He deserves the credit for bringing in professional management and return to investors



    Oct 19, 2012

    "Whether or not TCI's appeal is upheld in the court of law, the case will certainly teach the government to take the interest of minority shareholders of PSUs more seriously."
    I can barely suppress laughter at this statement! Really?!!

    The Childrens' Investment Fund DOES NOT HAVE A CASE HERE.
    TCI Fund bought Coal India Shares in its IPO, and as such is expected to read the DRHP carefully. Two very clear risks are pointed out: Risk 17 and Risk 55, wherein it is clear that Coal India continues to remain a government owned company, helping it OBTAIN MINING RIGHTS AT DIRT CHEAP RATES. Pricing will be decided in consultation with GOI AND more importantly, such decisions may be in conflict with the interests of other shareholders.

    End of debate..the judge will throw this case out on day is minority shareholders who need to learn their lesson here. Acknowledgements to Dr. Sanjay Bakshi of fundooprofessor wordpress com


    Salgia Suresh

    Oct 19, 2012

    Rahul Bajaj is open to questions and often more than willing to explain the positions. He is known for his candid discussions with humor and respect

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