The truths of an untruth - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
The truths of an untruth A  A  A
9 JANUARY 2009

The level of crookedness of a crook is not a function of the colour of his skin. We have crooks all across the world and the colour of their skin varies.

Crooks are also endowed with all sorts of degrees, or no degrees.
They may have MBAs from some of the best universities in the world. Or they may have degrees from average schools and universities. In some cases, no formal education.

Crooks may come from rich families or from poor families. From large families or small families. Or they may not have any families.

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Crooks are crooks. Whether they work for Wall Street firms; global or local banks; or multinationals that bribe to get contracts. Sometimes the crooks work for " or become - well connected real estate developers. Or set up investment management and advisory companies.

This particular crook helped create a software company with annual revenues of USD 2 billion. Satyam has 185 of the Fortune 500 companies as its clients.

And crooks have no religion. Or, like terrorists, no nationality. But, if confession letters are any indication, then Mr. B. Ramalinga Raju must be a good Catholic. His confession letter is an extraordinary one not for the clarity of facts but, rather, for its simple ending: "I am now prepared to subject myself to the laws of the land and face consequences thereof."

So, Mr. Raju will face the "consequences thereof", whatever they may be. Whenever that may be. And like many crooks before him he will have left behind shattered careers, broken families, and poorer investors.

Prevention, not a cure
Crooks, like terrorists, have a single minded purpose of achieving their objective. You can block one avenue of access but they will find other ways to reach their objective.

A crook has a desire to cheat, to lie - so as to extract what is not rightfully theirs. A terrorist wants your life because he wishes to destroy your "happiness" and make the world aware of his "cause". A crook wants your money, your life savings " he has little use for your heart and soul.

In the old days, there were no credit cards. So we would line up at the banks and withdraw money. When we stepped out of the bank, a crook would bump into us while his friends snatched our plastic packet with the currency notes in it. Then the world went to electronic payments and credit cards. Money still gets stolen, but now by crooks who understand the electronic highways of theft.

Have we stopped going to the bank or using credit cards? No, we are careful on how we step out of a bank. And with whom we share the credit card information.

The responsibility of the irresponsible
But there is no excuse for those who should have asked the questions.

Starting with the auditors. They are the gatekeepers of the accounts. They sign off on the accounting statements presented by company managements to the Board. What were they doing? Did they not ask to see the invoices to verify the value of the business contracts Satyam claimed it had? Or the expense sheets to then work out the operating margins? Or the "cash" balances?

The Board can be questioned on the aborted Maytas acquisition. And they were. But when auditors present a statement of accounts, how can a board member expect these to be false? The Board cannot be expected to rewrite the account statements: they need to rely on what the auditors present. That is why companies have auditors.

But the auditors have clearly failed. Just as Arthur Andersen failed in the case of Enron. And the failure of the auditors of WorldCom. Just as the audit firms failed when Unit Trust of India was effectively in default to its unit holders 9 years ago.

Just as the rating agencies failed when they rated junk debt as solid AAA debt so that the Bear Stearns, Lehman's, and Merrill's of the world could use their distribution channels to sell useless paper for a fee to buyers around the world.

Or just as some of the investment bankers have failed. Sometimes they bring these "hot", overpriced and must-have IPO-s and sell them to investors lulled into greed and easy money.

At the least, those who fail in their duty " and act with a criminal intent - should be shut down. That will sift the world of a lot of crooks " and crooked businesses. Although new crooks will be born every day.
Till we get genetically cleansed DNA in our system, we need to be careful.

The market speaks its mind
Interestingly, the fears of investors were out there for all to see in the stock market.
The Indian stock markets collapsed when this confession letter was released.

We don’t always agree with the market’s instant reaction and with its daily conclusions.
But we listen and watch.
And don’t quite know what to make of it.

As Table 1 indicates, there were 13 Tata companies that did better than the Index on January 7th while 6 Tata companies did worse. Tata Motors, Indian Hotels, and Voltas were the better known Tata companies that got knocked down more than the Index. All the 3 Mukesh Ambani companies did worse than the Index. All the 6 Anil Ambani companies did worse than the Index.

The real estate companies like Unitech (-20.7%) and DLF (-16.2%) lost more than the NSE 50 Index (-6.2%). ICICI Bank (-10.6%) and HDFC Bank (-8.3%) were also not spared.

Table 1: What the market said
S&P CNX NIFTY 2,920.40 (-6.18%)
REL PETRO 84.05 (-7.74%)
REL.INDUS.INFRAS 361.45 (-11.82%)
RELIANCE 1,200.75 (-12.41%)
S&P CNX NIFTY 2,920.40 (-6.18%)
RELIANCE POWER 112.80 (-8.70%)
REL NATURAL RESOURCE 53.40 (-13.52%)
REL. INFRA 558.60 (-13.63%)
RELIANCE CAPITAL 517.50 (-14.25%)
RELIANCE COMM 206.50 (-17.07%)
ADLABS FILMS 177.45 (-17.35%)
TAYO ROLLS 83.95 (-2.38%)
TCS 504.80 (-0.32%)
TRENT LTD 337.75 (-0.60%)
TATA TEA 619.35 (-0.86%)
TATA CHEM 175.15 (-1.07%)
TATA FINANCE 39.50 (-1.13%)
TATA POWER 795.40 (-1.32%)
TATA COFFEE 155.55 (-1.61%)
TITAN IND. 895.25 (-3.01%)
TATA TELESERV (MAH) 21.65 (-3.35%)
TATA SPONGE 137.00 (-3.79%)
TATA COMM. 504.85 (-4.95%)
TATA STEEL 233.75 (-5.38%)
S&P CNX NIFTY 2,920.40 (-6.18%)
TATA MOTORS 174.15 (-6.60%)
IND HOTEL 43.90 (-6.70%)
TATA ELXSI 95.35 (-8.14%)
RALLIS INDIA 324.95 (-9.86%)
VOLTAS 54.30 (-11.99%)
ALL NSE prices: January 7, 2009
Tayo Rolls is listed only on the BSE hence BSE Price is shown

Is the market telling us that these companies which lost more than the Index have questionable numbers?
Or is the market telling us that these companies are good but " if there is a freeze on money flows because of the Satyam fraud " these companies will not be able to get the money to fund their rapid growth?

Or were these stocks down for some other stock-specific reason which coincided with the January 7th "confession day"?

Reliance had a fire in its Jamnagar factory, so that may be a reason why the share price declined sharply.
Maybe less property was sold by DLF, Unitech and other real estate firms that day?
Or less people walked up to ICICI Bank to take a 30 year loan with no down payment?
And HDFC Bank was seen to be in competition with ICICI Bank for market share?
Or Tata Motors sold only 10 trucks that day instead of 12?

I don’t know. But I note the price action of a market whose movements I have not always understood.

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Huffing and puffing
The media, though, is having another wonderful week with yet another topic to panel-ise to death.

So, this will be branded as India’s Enron. Sorry, that title went to Unit Trust of India’s mystical valuation of its Unit 64 Scheme.

Or it will be branded as India’s response to the Ponzi scheme run by the infamous Mr. Madoff. Sorry, that title went to the chit funds of which Peerless was the most visible.

And solemn fund managers " of all nationalities - will say that this makes India look bad for foreign investors. While that is true, the way our governments have run the oil companies and the PSU banks has already made India look bad. And the way most of these fund management companies have tricked their investors over the years with useless products, they probably need to get their own house in order.

And some investment bankers will say that action needs to be taken to punish the guilty so that we can sell the India story again. A truism, indeed: clean up and sell the re-branded "Incredible India". But maybe those bankers should ask make a list of overpriced IPOs they sold to you " and keep that list under their pillow every night as they pray for forgiveness.

And the lawyers will say corporate governance needs to be restored. I agree. Shut down the law firms that defend crooks and crooked companies.

And everyone will huff and puff and put the whole country to sleep. But, dear reader, in case you have not noticed, we live in a crooked world.

Governments in most countries have failed their people. They have defrauded them of happiness. They are elected on promises and hope. They fulfil some of their promises. Most live in an election manifesto.

The central bankers of the world are at risk of failing in their vigilance to maintain the value of their currencies. They asked our forefathers to surrender their gold - the de facto currency " and move to paper currency. But it was not "paper" they promised, this was special. It was "fiat" currency " secured by the knowledge that there was an underlying value of gold in the banks. They are now printing paper currencies and selling gold. The fraud that the well-connected banks and financial firms played on the investors is about to be masked by a bigger fraud of the central banks in many countries. The US and UK central banks are bent on making the paper currencies their citizens own worth even less.

It is, as it is
So, here we are.
Small people with big ambitions.
In a big world - full of big crooks.
But at least we are armed with the knowledge that crooks exist.
That there is a gang of people waiting to accost us as soon as we step out of the bank with our life's savings.

Does that mean we must never go to the bank because the crooks can steal our money?
That we should stop investing in shares?

Despite the Raju’s of the world, I know that the stock market represents a fantastic way to invest money in people who have dreams and the ability to execute those dreams. To invest in entrepreneurs who can build solid businesses that provide services and products to a growing number of buyers.
To ride the evolution of "Incredible India" for the next few decades.

Indians " like others in the world - will still buy bread, wear clothes, watch movies, and use mobile phones.
Investing in the right companies will give you good returns.
Neither the bust of Unit Trust of India; nor the losses from the over priced IPOs; nor the fact that Mr. Raju rode a tiger that went out of control should stop us from investing.

But we need to be careful which companies we invest in; which managements we back.
Every time we shake hands, we need to ensure we have our five fingers back with us. Intact.
If we get four fingers back, oops, we know we made a mistake.

Better not shake hands again with that person.
No matter what they promise you.
No matter how well their stock has done in the past.
No matter that your friend tells you he has made a "killing" from investing in that stock.
Keep your hands in your pocket, save your fingers.

The sun rises
I have no insights into why Mr. Raju indulged in this fraud.
Or what made the auditors apparently fall asleep at the gate of the money flows.

But there will be a sunrise tomorrow.
And it will be in the east.
And there will be a sunset tomorrow.
And it will be in the west.

These are universal truths.

After twenty four years in the research and investment field, we have tried to build our own set of "investment truths". Unlike the universal truth of the sun " they are still evolving and we learn new things every day. And we try to remember these truths as we make our assumptions, our estimates, our guesses on what the businesses we invest in will look like " and how these managements will behave.

The Satyam episode is not shocking, but the confession letter was quite a surprise.
There is nothing that any regulator can do to prevent these frauds.
But there is a lot that the system can do to punish the guilty to discourage the frequency of such frauds.
And, most importantly, there is a lot that you can do to ensure that your money is in the hands of those who understand the risks of investing.
Risks which are not measurable by any statistical tools.
Risks which are not listed in any newspapers alongside the performance numbers for the mutual funds.

So, tread carefully, and keep investing. And if you are not sure about the comfort level of the investment, don’t greet the offer with a handshake " use the traditional "namaste" with folded hands. And walk on with your head high " and the money safely clutched in the five fingers of each hand.

Disclaimer: We own some of the stocks mentioned in the article for our clients. We do not own Satyam for any actively managed client accounts. Satyam was owned by the Quantum Index Fund which, by its objective and characteristic as a "passive fund", had to mirror the NSE 50 Index.

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