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Of management, trust and investing
May 27, 2006
This is a crazy market with all kinds of stocks going up but now more than ever, there is a common refrain on whether a management is good, bad, or whether it's clean or unclean. In this kind of market, perhaps it doesn't matter but people who have been in the market for sometime, will tell you that management is one of the most important things, which should influence an investor's decision to buy a stock or not.
But it's easier said than done because managements tend to be savvy. So, it's difficult to sometimes judge, whether you can trust a management or not? Sometimes, history is a very good indicator of whether you can go back and trust and figure out whether this management is going to create wealth for you, as an investor.
Jamshed Desai of IL&FS Investment told CNBC-TV18, how he goes about rating managements, how important a management is to him in selecting a stock and what are the key things, which stand out on whether a management is good or bad, shareholder and investor-friendly or not?
Excerpts from an interview given to CNBC-TV18
How important is it to figure out whether a management is good or not?
I think there is no clear mantra in terms of putting out P/E ratios or a score to management rating. In a sense, each investor has to come out with its own rating. But I think one has to really judge managements in terms of what they do and how they are seen to be doing it, whether it's in the best interest of shareholders and stakeholders at large and this is a process that pans out over a long period of time.
So, it's very difficult to pass judgment on a management just on the basis of one decision or at one point in time for a single year and to rate managements just because the company is doing well or not so well, would also be unfair.
Therefore, there are lot of things in terms of how the stock markets rate managements, over a slightly longer period of time and that does tend to have a tangible impact on the way companies are perceived and valued in the stock market.
Would it be one of the top three things that influence your decision about buying a stock?
Surely because management interest clearly has to be aligned to shareholder interests over a longer period of time and a lot of managements do tend to tell us that they are acting in the best interest of the shareholder.
Sometimes, those decisions tend to be driven due to short-term considerations and that tends to skew things and they may be right sometimes and minority shareholders must go along in their best interest because management knows best. But I think those actions must really count in the long run.
Some people do not regard managements so highly, they say that bad management in a good industry might be better than a good management running a bad business. Do you agree with that?
I think that's an ongoing debate and it's a debate that will never end. But I do tend to believe that a good management in a bad business, can actually do only so much to turn that bad business around. Which is also dependent on various factors, like business cycles and the competitive nature of those businesses.
Whereas, if you have a business, which is really in a sweet spot for a very long period of time - whether it's cyclical or non-cyclical - then even a bad management will know that this is just too good a business to let go and the business will just keep running on it's own steam and therefore bad corporate actions, bad management actions will actually be shrouded by superlative performance of the underlying business as a whole.
This can happen very often in commodity companies, which are actually driven to a very large extent by commodity prices and therefore bad corporate actions, over a long period of time can actually have deleted its impact in the next downturn. We've seen that happening in industries like steel, cement and in lot of commodities in the last 10-15 years, in this country.
How do you define a good management?
I think, strategic issues play a very important role in terms of where the managements have set their eyes? What it wants to become in the long-term and how it blends in long-term aspirations of that management along with the short-term requirements of meeting certain profit targets, meeting street requirements in showing shareholder return in the short to medium term as well, and blending that is very important.
Long term decisions such as building brands or building capacities, expanding geographically or acquiring new companies - whether it's organic or inorganic. These are the long-term strategic decisions, which will have a long-term impact on companies.
In the short run, I think managements need to grapple with shareholder expectations, stock market expectations, expectations of stakeholders at large and therefore they need to take certain short term measures, which are in keeping with the long term goals.
Therefore, you find companies sometimes embarking on a long-term capex plan, but they tend to differ that capex over a period of time, depending on the cash-flows, depending on the interest rates, depending on the overall business cycle.
So, I think that's a hallmark of a good management, which doesn't go the whole hog at one shot and loads up the balancesheet and then pays a heavy price when the chips are down.
In this kind of a market, a lot of managements seem very focused on their stock price at the current point. Is that a good thing to be a market savvy or does it sometime come in the way of strategic thinking and long term decision-making?
Sure it does come in the way of strategic thinking. I know a lot of managements that are overly fixated by the stock price and that's not a good thing to do because then it's basically trying to put the cart before the horse. The stock price is an important metric for measuring management output and performance over a longer period of time.
In the overseas markets, a lot of companies actually dabble in their own stock. In India, it's frowned upon, would you have reservations about companies or promoters who actually trade in their own stock?
Yes definitely. You've got to remember that although, we have insider trading norms, they are not strictly enforced. Therefore, there are a lot of loopholes by which the managements can get away with that and I think it's to Sebi's credit, that we have certain guidelines which forces managements to actually make disclosures, every time they buy and sell significant amount of shares.
If somebody has time and patience to actually track management actions, in terms of stock purchases and sales over a period of time, then one gets an inkling as to whether the management is putting its own money where its mouth is and that's a very strong indication, as to how the management really perceives its business going forward.
Do you go by their past track record of how they have been able to implement their vision, statements and strategic thinking or do you buy a promise which the managements spin out?
I know a lot of managements which have made forecasts and these statements tend to be a guiding post for a lot of managements but I don't think it is etched in stone because things change along the way and it would be little unfair for the investors also to hold such statements very hard and fast against managements.
If one were to look in retrospect and see how close the company is actually been to achieving those goals and one finds a big disparity between them, then I think there is reason enough for investors to question the management about its intent or ability to fulfil those goals.
I would generally think, that a company should actually strive not so much in terms of growing assets and topline, as focusing more on profitability and return on capital, RoC, over a longer period of time because that's what a long-term investor would generally reward.
What about capital raising?
Capital raising is very important because I think the ultimate Holy Grail is the balancesheet and how you manage the numbers in that balancesheet and because the ratios will be derived out of that balancesheet. Therefore, if you load the balancesheet with excess flab, your efficiency ratios will start getting dampened.
So if you are raising capital and you are going to put it into good use and the return on the incremental capital is going to be equal or more than what the existing business generates, then that's fine by me.
The markets are going to latch onto this in the long-term and de-rate your company because any company that has declining return on equity will generally see some sort of de-rating in terms of the P/E ratio, over a longer period of time.
Do you look at paying out large dividends or going in for a buyback, as if the management is proactively trying to create wealth for shareholders?
Yes absolutely. I think it just shows that the management is acutely conscious of rewarding shareholders, not through physical payouts of cash but also in terms of managing stock price in a proactive fashion. You only want to do a buyback, when you really have no other avenues left in terms of deploying that cash. So, buybacks have to be EPS accretive over a longer period of time and should not really dampen the capital ratios as well.
So managements, which go for buybacks, do tend to do their homework on these lines and then they actually go out and do the buybacks. Buybacks by themselves cannot prop up a stock price for long because once the buyback is over, the stock price will fall if the underlying business is inherently weak.
There was a thinking at one point, that family managements are not necessarily good and executive managements are better. Is there any such thumb rule to go on?
I think it is to the credit of Indian companies and Indian family-run businesses in the last 10-years particularly, which has actually debunked this theory that family managements are not for shareholders. But we have a plethora of Indian family-owned businesses, which have actually done much better than their professional counterparts and once again this has to be judged over a longer period of time.
The big difference in the Indian context is that the degree of accountability between Indian companies towards their shareholders and what happens on Wall Street, is very different. On Wall Street, you have managements, which can be sacked by a body of shareholders, we haven't seen that happening in the Indian context and until we have that kind of situation, we will still have underperforming, professional managements and owner managements, which actually keep doing well.
Especially large, old world brick-and-mortar companies which were managed by families, have actually realized the mantra of shareholder value creation, over a long period of time and are taking a lot of steps in doing so. Another thing is, there are a lot of companies where family ownership is perhaps too low for them to be committed enough and that could be an issue sometimes, but not always.
How important is the board? When you look at a company, do you look at the composition of the board at all?
It is a comforting fact, if you have a board that is decorated by a lot of luminaries and people from esteemed backgrounds, with a track record of a high degree of integrity and whose past actions on other company boards have generally been very astute and shareholder-friendly.
But, that alone doesn't really count for much beyond a point because ultimately, on Indian boards, it's the operating management that really calls the shots to a very large extent.
Give us a thumb rule - when you are looking at a company, the three warning bells which could ring immediately when you are trying to assess a management? What are the things, which typically leap out?
I think the most important thing that I would look out for is, the manner in which the management allocates capital over a longer period of time. Second, the manner in which management actions are generally taken - in terms of aligning themselves, with shareholder interest.
Third, the focus of the management, in terms of what that they bring to the table, as well as the actions that they take in terms of not just strengthening the existing business but also creating entry barriers for that company. This means what measures do they have against competition and other forces. So these are the three broad things that I would generally look at.
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