Investment firms have used different philosophies developed from Benjamin Graham and before and to the hedge fund greats of today. But India demonstrates its own unique features which are tweaks to these approaches. This article is to outline those unique aspects.
a) Very unlike western economies (not completely though) government direction can create significant change in fortunes of a firm. Inability to understand government direction and political pressures render large swathes of market capitalization less understood:
b) Large promoter holdings – Indian corporates mostly are held significantly by promoters groups which makes renders them to a very large extent immune to pressures from minority shareholders resulting in them not being ‘public’ in the true sense of the word. Reliance Industries for the longest time was one monolith having pretty much all businesses under them until the brothers had a fight. This unlocked massive shareholder value which no minority pressure would have brought about. Tata group companies have significant cross-holdings which get valued at discount but are believed to necessary to ensure group control. Consequently, knowing or judging the mind of the promoter becomes important. This also creates a large network of brokers who peddle stocks based on ‘inside track’ rather than better understanding. Multi-national corporations with their arms in India which had been forced to list in the 1970s have also tried to dodge corporate governance standards i.e. Maruti Suzuki parent setting up an auto plant in Gujarat not under its listed subsidiary, large royalty payments by the likes of ABB, Siemens etc, P&G has a unlisted subsidiary doing significant business in India (despite having a listed entity).
c) Subterranean KYC and dodgy accounting – Given the large swathe of underground economy and political influence knowing ‘real’ reputation of the promoters is super important. There are well-known examples of Satyam Computers, Financial Technologies etc. Even lenders try and protect the mistakes they have made (and regulations help) like Deccan Herald or Bhushan Steel keeping issues away from public view longer. While mainstream companies (including MNCs) are relatively easy to check on but it is the smaller companies and the potential 10-baggers which are more difficult to glean.
d) Regulatory overdose – Interesting and large segments like telecom (remember 2G license), media (FDI restrictions in print, radio shareholding), pharma (price controls, clinical trial related norms) are hobbled by regulatory maze which restricts ease of operations and changes in regulatory environment create significant valuation changes. The strong arm of government trying to force-fit the economy into the regulations is evident creating friction costs.
e) Unbalanced market – In effect the two key drivers of market valuations are FII interest or promoter’s direct to indirect interest. The domestic players are not and are not seen to be valuation drivers. Consequently, market participants in essence look for clues at these two ends.
f) Some more examples of atypical characteristics:
Having said this, the core judgment parameters of good companies remain universal:
a) Very unlike western economies (not completely though) government direction can create significant change in fortunes of a firm. Inability to understand government direction and political pressures render large swathes of market capitalization less understood:
- public sector banks – clarity of government stake and recapitalization, approach to bad debt;
- power generators – no tariff adjustment due to elections (i.e. Torrent Power);
- real estate companies – approval delays (i.e. Mumbai builders);
- infrastructure builders – stalling of payments by authorities like NHAI, delays in environmental clearances.
b) Large promoter holdings – Indian corporates mostly are held significantly by promoters groups which makes renders them to a very large extent immune to pressures from minority shareholders resulting in them not being ‘public’ in the true sense of the word. Reliance Industries for the longest time was one monolith having pretty much all businesses under them until the brothers had a fight. This unlocked massive shareholder value which no minority pressure would have brought about. Tata group companies have significant cross-holdings which get valued at discount but are believed to necessary to ensure group control. Consequently, knowing or judging the mind of the promoter becomes important. This also creates a large network of brokers who peddle stocks based on ‘inside track’ rather than better understanding. Multi-national corporations with their arms in India which had been forced to list in the 1970s have also tried to dodge corporate governance standards i.e. Maruti Suzuki parent setting up an auto plant in Gujarat not under its listed subsidiary, large royalty payments by the likes of ABB, Siemens etc, P&G has a unlisted subsidiary doing significant business in India (despite having a listed entity).
c) Subterranean KYC and dodgy accounting – Given the large swathe of underground economy and political influence knowing ‘real’ reputation of the promoters is super important. There are well-known examples of Satyam Computers, Financial Technologies etc. Even lenders try and protect the mistakes they have made (and regulations help) like Deccan Herald or Bhushan Steel keeping issues away from public view longer. While mainstream companies (including MNCs) are relatively easy to check on but it is the smaller companies and the potential 10-baggers which are more difficult to glean.
d) Regulatory overdose – Interesting and large segments like telecom (remember 2G license), media (FDI restrictions in print, radio shareholding), pharma (price controls, clinical trial related norms) are hobbled by regulatory maze which restricts ease of operations and changes in regulatory environment create significant valuation changes. The strong arm of government trying to force-fit the economy into the regulations is evident creating friction costs.
e) Unbalanced market – In effect the two key drivers of market valuations are FII interest or promoter’s direct to indirect interest. The domestic players are not and are not seen to be valuation drivers. Consequently, market participants in essence look for clues at these two ends.
f) Some more examples of atypical characteristics:
- Benjamin Graham ‘cigarette butt’ has a smaller sliver of followers given the low level of non-promoter holdings which make hostile M&A, restructuring regulations etc all the more difficult. Significant numbers of Promoters have no incentive to get the firm to fair value unless they have some benefit (i.e. raising incremental cash). CEO compensations have no correlation to stock or company performance.
- Generally, declines below book value for real estate & infrastructure builder lead to attractive opportunities – Here one needs to be more than careful given most have political patronage and, therefore, where is the wind blowing.
- Lenders want to keep working with the promoter despite significant breaches in leverage arrangements. As regulatory lax in NPA recognition and limited history of taking strict action against defaulters result in creating illusory sense regarding firms cash flow stability until it reaches the cliff. Kingfisher Airlines is an example where the general public was for a long-time unaware.
- Doubling up on leverage – NBFCs and special situation desks lend to promoters on their shares in structures which do not require disclosure.
Having said this, the core judgment parameters of good companies remain universal:
- Whether product has repeat usability?
- How well is the product plugged to the customer value chain?
- Is there high switching cost?
- Are the revenues annual or lumpy?
- Can the firm pass on cost inflation?
- Does it provide critical infrastructure?
“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” ― Mark Twain
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