The No. 1 reason why companies make stupid decisions!

Nov 29, 2014

In this issue:
» The dramatic rise in India's petroleum consumption
» When will the tech bubble burst?
» Week's roundup of the global markets
» ...and more!

Every now and then, there comes along an instance of a well known businessman or the management of a big company going ahead and doing something very silly. Something that is so bereft of economic sense that it has us scratching our heads in wonder.

Like buying an airline for example. Saying that these things don't make money would be a huge understatement. They actually burn money, and burn money at a rate that would make your head spin.

Yet we have numerous cases of big business men, who have a long list of savvy consultants at their disposal, going ahead and buying an airline.

Take Vijay Mallya buying Kingfisher Airlines for example. We all know how that saga has played out.

Or then Sun TV promoter Kalanithi Maran buying Spicejet. He bought his stake in the airline in mid 2010 for about Rs 9.4 bn. He is reported to have said at the time, "All my steps are calculated, I am not going blindly with intuition." What happened next? The last 3 financial years itself have seen the airline lose Rs 18 bn, or twice the amount he bought it for. In just 3 years!

Plunging into a business known to be a bad one is not the only variety such instances come in.

It takes on many other forms. Like buying an IPL team (where the buzz word is 'players' not 'profits'). Or making a very expensive acquisition (with promoters never short of an elaborate story to justify it).

Which gives rise to the big question - why do they do it? Warren Buffett in a recent interview offers a clue. Having been in countless board meetings of hundreds of companies, he points out that a lot of decisions in the world of business are made simply because "all the other kids have one". In other words, at base often lie reasons other than pure economic sense. They can range from promoters feeling the need to own something because they may consider it prestigious, to simply doing it to assuage their egos.

And all of that would be completely fine. They are free to do what they want, whatever the reason may be. But here's the issue - ever so often, instead of doing it in their individual capacity, you have them doing it through their publicly listed companies, of which they are not the only owners! Using the resources of such a company in which there are thousands of minority investors who have little power to disapprove such moves is unethical to say the least. The latter end up becoming mute spectators to the wealth destruction that usually follows.

The only way out for a wise investor is to meticulously avoid companies whose promoters you think will be prone to making such decisions. Indeed, it is not very difficult to separate the mindless from the sensible.

Do you try and avoid investing in companies with vain promoters? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
India's GDP growth has come a long way since the country adopted the democratic government system in 1950. Naturally, for a growing economy such as ours, demand for fuel and energy also increased. As today's chart of the day shows, there has been quite a surge in India's consumption of petroleum products from 1951 to 2014. In fact, there has been a consistent rise every decade. Further, assuming that the Modi government delivers on its reforms agenda, we are bound to see a ramp up in growth and infrastructural development in the country. This will then automatically translate into sustained demand for fuel and energy going forward.

Right now, India imports around 70% of the fuel that it consumes. This then has an important bearing on the trade balance of the country and the way the exchange rate pans out. What more, this also makes India vulnerable to how the international crude prices behave. The longer term solution is to make India self sufficient when it comes to energy. But is that easier said than done? Only time will tell.

Dramatic rise in petroleum products consumption

It seems there's no stopping the Indian markets. At this rate, fortress 30,000 on the Sensex is going to be breached perhaps much sooner than expected. Amidst all the euphoria though there's one unsung hero that's not quite getting the recognition it deserves. And it answers to the name of crude oil. Yes, that's right. The price of the world's most important commodity has had a huge role to play in taking the indices to where they are today.

And the good news is that the party may not be over just yet. In its meeting yesterday, OPEC, the oil cartel came to the conclusion that it it's not going to tinker with oil supplies so that a floor could be set on the prices. Instead, it will let the market forces decide what should be the ideal price for oil.

If this is indeed the case, given the oil glut and a weak demand scenario, crude oil under US$ 60 per barrel is very much on the cards. What does this mean for India? Well, petrol prices in the country can go below Rs 60 per litre for the first time since 2011. However, getting complacent about this is the last thing the Government should do. Reforms clearly need to pick pace otherwise we would be back to square one as and when the crude prices start rising again.

When talking about bullishness in global markets, one can hardly ignore tech stocks. Just two days ago, we had written about the speed at which valuations had expanded for a company like UBER. Crazy valuations are being accorded to all sorts of tiny tech firms on the NASDAQ. The index itself is closing in on the 5,000 level. So will the party end soon?

If one were to look at the last two bull markets, one thing is quite clear. Just about the time when people began talking about valuations becoming irrational in Silicon Valley, these stocks took off on a northward journey. The reason was that venture capital and private equity investors began playing the 'bigger fool' game. They believed that everyone was putting money into these firms just to speculate. Therefore, they could buy these stocks at expensive prices and sell them later to a 'bigger fool' at a higher price. Those people would in turn, sell out to someone else at an even higher price.

This is what happens in the final stages of every bull market. As long as prices keep rising, this game will continue. When the tide turns, a lot of people will lose money. It happened to tech stocks in 2000 and 2008. Are we near the end again? We are convinced that this bubble too will burst. However, we won't be surprised if the insanity lasts for a few more quarters.

Majority of the world markets continued to remain buoyant in the week gone by. Following OPEC's decision of not cutting oil output, benchmark crude oil prices slipped further and reached their lowest levels since September 2010. Although weak crude prices bode well for the global economy, it poses a challenge to major central banks that have been trying to keep inflation high to revive the sluggish economy. The People's Bank of China had cut benchmark lending rate and deposit rate by 0.4% and 0.25%, respectively last week. As a result of the stimulus, the Chinese index was the biggest gainer (up 7.9%) for the week. Among other Asian indices, Hong Kong and India were up by 2.3% and 1.2%, respectively. Even Japan and Singapore markets posted marginal gains.

The European Central Bank is also likely to take up more stimulus measures to boost sentiment. While Germany and France recorded gains, the UK markets were down marginally for the week. The US markets remained flat for the week.

The Indian indices continued to deliver positive returns on optimism of falling oil prices providing room for rate cuts in future. Among the sectoral indices this week, realty and IT stocks were the top performers, while FMCG and BSE Small Cap stocks were the biggest losers.

Performance during the week ended November 28, 2014
Source: Equitymaster & Yahoo Finance

 Weekend investing mantra
"Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad's body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of the company. We've observed many kisses but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses - even after their corporate backyards are knee-deep in unresponsive toads." . - Warren Buffett

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2 Responses to "The No. 1 reason why companies make stupid decisions!"


Dec 2, 2014

I totally agree with your views on companies and promoters making stupid decisions. Every ordinary investor must avoid such companies and promoters. That said, I feel, the taxation policies of the Government are hugely responsible for the plight of Airline Industry as a whole. Taxes eat into a large share of the revenues of the Airlines.Even Air India is suffering but, government is not seeing the reality that Central and State taxes are responsible for driving the Industry into red. That said, every investor also makes foolish decisions. How many people make real analysis before investing? people go by tips, rumors and so on, without checking their veracity even a little. After Buying, people keep on retaining shares of companies, which are sinking and sinking. Sentiment plays a Huge part in the Buying and selling decisions of individual investors also. And, many Investors will Justify a bad Purchase, until, they can no longer justify it by any logic.

Like (1)


Nov 30, 2014

In fact, more stupid are our banks who finance such ventures in spite of knowing end result.

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