Earnings Per Scam = the new EPS - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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20 DECEMBER 2010


Most of us boring, value managers in the field of research and investments worry about the long term sustainability of earnings per share (EPS); the smartness of the managements to navigate their businesses across different business cycles; and grapple with the most appropriate PE multiple (the Price-to-Earnings ratio) that we should ascribe to these forecasted earnings per share.

In the pre-1991 liberalisation days, we would take the estimated earnings per share that we had for a company and minus the amount of money we expected the founder shareholder of the established businesses to steal some money out into their private companies and bank accounts. You see, in the pre-1991 days, the BSE-30 Index was trading at 550 (no, I have not missed a zero) and there was no concept of a PE ratio because there was no mutual fund manager to buy stocks. There was only UTI and they did not buy stocks, they supported friends of government and bought the shares of their companies not based on any EPS and PE ratio but based on something else. That is why UTI, eventually went bust. The rot had to show up one day. And it did.

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So, mathematically, any sane and rational analyst (eh, there really was nothing like an equity analyst, honestly) in 1990 would work on this formula:

Expected EPS = (True EPS) - (theft from company).

But the IMF and their forced liberalisation of the Indian economy sprinkled with the man with the Lexus, Big Bull Harshad Mehta, changed all that. (Of course, the Indian PR firms made sure that the media gave all the credit to some fictitious Dream Team.)

Riding the Big Bull
Since July, 1991 the markets were on a tear and the founders realised that one rupee stolen from a company in which they owned 30% was Rs 1 of rokda (crisp, hard cash) in their bank. But, if they kept that Rs 1 in the company and let it flow to EPS, then a PE ratio of 20x on that Rs 1 of extra EPS that they allowed to remain in the company added an extra Rs 20 to the share price and the market cap of their company. And because they owned 30% of the company, their wealth was Rs 6 - an increase of 6x!

So, they had a choice: keep stealing that Rs 1 (technically, they stole only 70 paisa since 30% of the Company anyways belonged to them) every year or leave it in the company and have a net worth (from a higher stock price) of Rs 6.
Being the legendary Indian businessmen that they were, they kept the Rs 1 and stopped stealing. Some more creative ones probably brought their stashed cash back into the company's "books" and added to extra profits so they could get a higher multiple. And their wealth took off from this magical world of financial engineering that even the Wall Street geniuses could not replicate.

When they needed cash, they offered some of their shares for sale in a private placement or some kind of offering to fund managers like me, the "bakras" of the first wave of FII buying in the 1992 to 1995 India mania. And there was always the government owned institutions like UTI and LIC to place some shares with and generate some tax free white wealth. There was no Money Matters but they had their less visible predecessors.

In that era, the new way of estimating the earnings per share of a company was:
Expected EPS = (True EPS) + (money ploughed back)

But that was then.
We are in a new era of accelerated liberalisation.
A country with visits from the leaders of UK, Russia, USA, France, and China all in 5 months either has some fantastic night spots or some great business potential. Given that the Indian night life ends at 12 midnight in most cities and hotels, they must be here for the business.
A billion heartbeats are consuming and India is open for business - and loot.

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Riding the Tiger
The Bull is dead and gone: we are now in the age of the Tiger. Sure we have the sloth-like elephants around us and the so-called Navratnas have been pretty much left to die and shed their jewels to the private sector, but what are a few pools of swampland in a lush green forest of loot?

As the Radia tapes, the 2G scandal, the mining thefts, the SEZ scandals, the continuing real estate scandals, the questions on infrastructure contracts all indicates, there is a new EPS formula in vogue.

Expected EPS = (True EPS) + (money from each scam or project won with a bribe)

So, here we are, the boring, value managers in the field of research and investments who worry about the long term sustainability of earnings per share (EPS); the smartness of the managements to navigate their businesses across different business cycles; and grapple with the most appropriate PE multiple (the Price-to-Earnings ratio) that we should ascribe to these forecasted earnings per share.

But in this day and age, there is no significant, true EPS.
There is a lot of Earnings Per Scam, the new, modern day EPS.

And the job of the analyst is now to work out which entrepreneur has what connections and how will those connections translate into Earnings from the next Scam.

Normal earnings per share from normal business operations has now been significantly enhanced - and dominated - by the potential for extra EPS from having friends in government and paying bribes to get new business opportunities.

Yes, India is riding a Tiger.
Just like Mr. Raju did when he decided to get off the Tiger in January 2009, and announce a theft of Rs 4,000 crore.

In a recent interview, Mr. Deepak Parekh spoke about the need for "newer industrialists' and "genuine industrialists" and said that India does not need "cronies-come-lately".
I think Mr. Parekh is half-right; and half-wrong.
Yes, we need "genuine" industrialists but the list of the scamsters includes people whom he would classify as "older" industrialists.

Will India get off the scam-ridden Tiger?
Or will we continue as if nothing has happened and carry on with a stock market that rewards Earnings Per Scam, the new EPS?

I don't know the outcome of this but, for now, we have another EPS to factor into our forecasts on what could happen.
And this EPS comes straight from a beloved Prime Minister as he feebly holds on to the pallu of a swishing sari: the Eternal Prime ministerial Smile.


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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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Equitymaster requests your view! Post a comment on "Earnings Per Scam = the new EPS". Click here!

17 Responses to "Earnings Per Scam = the new EPS"

Ajay

Apr 8, 2011

An excellent eye opening article.
Thanks

Like 

naresh saraf

Dec 24, 2010

EXCELLENT CALCULATION OF EPS

WITHOUT THIS MAIL WE ARE MAKING MAMU

THANKS A LOT

Like 

Rupesh

Dec 22, 2010

Vaah Mr. Mukund. Thats quite nice a point that you make about the EPS calculation.

Anyways, what was refreshing about this article was that it did not come with the MF industry bashing and how they bribe the distributors for garnering AUM, unlike Quantum. Else, almost all the articles here had only one Honest Truth - Quantum might not perform as well, but they do not hire distributors to mis-sell.

Like 

rp77

Dec 22, 2010

"Dream Team" - well said Nagarkatte!!

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sundar

Dec 21, 2010

What you are saying is absolutely right, but then you need to address this to a wider audience. Why not forward a copy of your newsletters to PM, Madam Gandhi and the rest of the so-called think tank of the Govt. Let them feel the rebuke and let us hope, they will rid us of the scam-bam ministers they have imposed onus.

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ASHOK KASHYAP

Dec 21, 2010

Pl.send detail above article

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Gopinath Mavinkurve

Dec 21, 2010

EPS = Earnings per SCAM! With this new coinage, i guess we are bound to forget the original one forever! Even telephone conversations by those affected by the Radia-activity in our country will now discuss EPS during telephone conversations openly! Loved this piece!

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sunil ghorpade

Dec 21, 2010

there was an article in times by chetan bhagat(sunday19/12/10) likethis article.both are excellent.india is going to the dogs.

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Saurabh

Dec 21, 2010

Excellent article. Well written.

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pvthosar

Dec 20, 2010

EARNINGS PER SCAM - An EXCELLENT article !

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