While the index seems to show a different picture, a deeper analysis of the stock market reveals that last one year has seen a catharsis for the Indian markets with a significant divergence between the fortunes of businesses that have visibly better management quality, adhere to good governance practices and are efficient allocators of capital (these are more dearer today and have fared better, think HDFC, Bajaj Finserv, Kotak) than and the businesses that have questionable management probity, relatively poor practitioners of governance standards and have been bad allocators of capital (Yes Bank amongst others stands out). The Sensex is up +14.4% since January of 2018 till September 2019 while the S&P BSE Midcap and SP BSE Smallcap indices are down -20.9 -31.7% respectively in the same period.
Though one can sympathise with the loss of wealth suffered by most investors, this is the case of ‘chickens coming home to roost’. While the party that lasted from late 2013 came to an abrupt end by September 2018, the after effects are playing out now. Every day one hears about some scam in the Indian equity markets, about some subverted way in which the sponsors of the businesses enriched themselves while leaving the minority shareholders in a lurch. The main question to ponder is – why invest in businesses which look attractive on the face of it but under the veneer of a high growth great business of tomorrow lurks the shroud of bad behaviour.
As one looks back at the Indian markets and where many of these businesses used to trade, one wonders what all can be pushed around in the name of growth. Corporates which have been famous for short-changing minority shareholders or poor corporate governance track records were perched as new beacons of wealth creators. All the caution was thrown to the wind as the liquidity was plenty and debt was cheap! The debt fuelled growth was given rerating multiples by describing words like ‘inflection point’, ‘new business model’, disruption and all the other fancy things which are akin to saying, ‘This time is different.’
Peter Drucker used to say, ‘What gets measured, gets managed.’ The go-go markets are the perfect place to catch this in action. With investors focussing on growth and projecting that to arrive at valuations, savvy but unscrupulous businesses will talk on hours about their next growth plans, entering new geographies or opening new plants. The far more important things like corporate governance, trust, reputation, transparency and track record are the first things that get ignored due to the difficulty in measuring them. I remember reading reports from an analyst comparing a newly listed beverage company with top FMCG players to justify the valuation it trades at, another report comparing a regional jewellery retailers to India’s largest one. Needless to say, these reports never spoke about qualitative parameters but just the numbers. Both those businesses are either bankrupt today or on the verge of it. The turmoil in the market especially in many midcaps and small caps is largely their own doing, either by overleveraging themselves or by doing financial chicanery. It is likely to be difficult for quite a few of them to garner any interest from the investors in the near to medium term.
While an average retail investor can be forgiven for the lack of access or their eagerness to coattail the famous ones, the more surprising is the fact that most of these businesses had or continue to have some of the most marquee names as investors. When asked about this, many of them would say that hindsight is 20/20 and that there was no way they could have known that this was about to be! Not focussing on corporate governance is like walking out to bat without a bat in hand. Capital protection is the key tenet of investing and irrespective of the risk appetite, the difference between an investor and a speculator is largely this.
As Buffett says, ‘Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.’
The question is where does one go from here?
Yes, there is an economic slowdown and earnings growth is subdued. While the government has been doing its bit on the economic revival, it will take time for the recovery to happen. These times of slow down are the best time as an investor, is to analyse which businesses are doing the right things for the long term, which businesses are strengthening their franchises and will come out stronger. Valuations must be seen in conjunction with the quality of franchise. There are businesses which are swimming naked and best avoided.
Excerpts of this article appeared on www.moneycontrol.com and can be read here:
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