Why I'm Recommending a Company Whose Promoter was Barred from the Market

Mar 19, 2018

Richa Agarwal, Research analyst

A few days ago, I travelled to North India to meet the management of a company I had been researching for a while.

I had a little time to spare before my return flight, so I figured I'd try my luck to see if I could meet one other company.

This company had not been on my radar - and I had no intention of putting it on there (I'll explain why in a minute). But I was curious about the niche industry it operates in - the company is a leading player in an oligopolistic market.

As luck would have it, the management agreed to see me on short notice. And this unforeseen, unplanned, meeting turned out to be an eye-opener for me, and led to my latest stock recommendation for my small cap service.

Why was this meeting such an eye-opener for me?

It brought me face to face with my own anchoring bias.

Anchoring bias occurs when we rely on an initial piece of information to make decisions. So much so that the ensuing data and facts, no matter how critical and relevant, are faded and pushed to the background.

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It's basically like first impressions when we meet someone. We form an impression of a person when we first meet them, and no matter what we learn about them afterwards it is hard to shake that first impression and look at them without bias again.

If you speak to a behavioral finance expert about the most common investing blunders, anchoring bias is likely to top the list.

Most often, in stock investing, anchoring bias is based on past stock price. For instance, you may not want to buy a stock at Rs 100 if you know it has traded at Rs 80 last week... Even if the real value of the stock is Rs 200...and the stock may never correct back to Rs 80.

But my anchoring bias was based elsewhere - I had a negative impression of the company on account of its past corporate governance issues.

You see, management quality is the hallmark for all my stock recommendations.

And the promoter of this company had some serious issues. He was involved in a case of alleged cheating and had shown unethical behaviour. The messy management history did not inspire confidence in me.

Despite this company ticking the right boxes on financial performance, I was not interested.

When I met the management team I learned that I was very wrong to dismiss the company. I was relying too heavily on my initial information - the promoter's tainted history.

Warren Buffett once said:

  • If past history was all there was to the game, the richest people would be librarians.
Your Investing Bias Could Stop You from Seeing Great Investment Opportunities

And Buffett led by example too: In 2011, he made a US$ 5 billion bet on Bank of America when it was struggling and its shares were tumbling. Last year, the bet paid off with roughly US$ 12 billion windfall.

Coming back to my experience...

When I met the management team, I realised that company has come a long way from its tainted past.

The management team at the helm of company's affairs is different from the promoter I had issues with. The promoter stake has come down drastically (a positive in this case). The business is now professionally run. The original promoter has a minimal role to play. And the current management has left no stone unturned to win back investors' confidence.

Consider this:

  • It has hired one of the best auditors in the country.
  • It has a stated dividend payout policy.
  • It has gotten rid of all subsidiaries that were not strategic to the business and led to transparency issues.
  • Lastly, the disclosures and management communication could put any large cap company to shame.

The current financial performance and strong quality of earnings reflect all these developments.

The company is the lowest cost player and commands the best margins in an industry with high entry barriers. It enjoys captive consumption of raw materials and fuel, which are the main cost components in the business.

But none of the above would have induced me to recommend the stock...had it not been for its undemanding valuations.

For this company, price is my due diligence.

The current stock price not only offers enough margin of safety, but an investment proposition that's hard to resist.

When I was forced to confront my bias, I found a gem of stock. Imagine all those great opportunities that have passed me by because I was not always wise enough to do this. I hope I learn from this - and that you too will catch your investment biases before they impact your investing process.

Happy Investing,

Richa Agarwal
Richa Agarwal (Research Analyst)
Editor, Hidden Treasure

PS: Richa's latest discovery is a stock she vigorously recommends - against all odds. Don't miss your chance to invest in it. Click here to get access to her small cap recommendation services.

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2 Responses to "Why I'm Recommending a Company Whose Promoter was Barred from the Market"

Ronish Baxter

Mar 21, 2018

So, what I understand by reading the article is that instead of focusing on what's gone by its important to focus on how it is performing at the moment and always keep a close eye on how the management is working to make a mark.

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Sridhar

Mar 19, 2018

Dear Richa

Your write-up is interesting.

I do not subscribe to your viewpoint. The biggest frauds globally have been committed by companies whose management teams had an impeccable track record, and whose auditors we're invariably the Big 5 or Big 4.

A crooked promoter, who has a "minimal" role in running the business, an “impeccable” management team, a “stated” dividend policy, and “captive consumption of the main cost inputs - raw materials and fuel”, and a very attractive valuation....

Sorry, I wouldn't touch it with a barge pole.

What about the org culture? Has it really changed from the time of the crooked promoter? And why should it have changed? What was the catalyst? The promoter had a change of heart, and found God?

The stock may very well turn out to be a multibagger. But I will not put my money on it.

Regards
Sridhar



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