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Hurdles you need to avoid, to be a successful marathoner – (Part 2)

In my earlier blog (read here:  Part 1 ), i had written about why business mangers should focus on running a marathon (in the business context) instead of a sprint. Should you be wanting to run the business marathon, hereunder are some hurdles that you need to steer clear of.

While the Nifty Index continues to flirt with 52 week highs in the current year, hundreds of companies in the mid/small cap space have witnessed huge capitulation. While retracing fund flows and overall inflated valuations (caused by a raging bull market over the last couple of years) triggered the fall, worries have resurfaced on questionable practices that several companies may have resorted to, especially after the recent auditor resignations in some investor-fancied companies.

Collated hereunder are some such practices (not necessarily accounting practices). These are typically overlooked in bull markets but get increased emphasis in bear/corrective phases of the market:

  • Manipulating earnings – Revenue is boosted by higher sales, to support the stock price OR pushed to subsequent quarters to show consistency in revenue growth going forward
    • Comment – Educated investors focus a great deal on cash flows. Inflating revenues, led by increased receivables, is immediately detected and clearly reflects the quality of earnings.
  • Manipulating volumes – Create artificial volumes (circular trading) in stocks to portray higher liquidity
    • Comment – Business managers should be more concerned on creating value in the business rather than being bothered about the stock liquidity or the price. Liquidity follows consistent performance, sooner than later.
  • Promoter stake hike / buyback – Announce token stake hikes or buy backs in a bid to ‘signal’ higher promoter confidence in the stock price
    • Comment – Should business managers see actual value in the stock price, buy max permissible quantities. Educated investors realize the irrelevance and fallacy of marginal stake hikes & buy backs.
  • Increased frequency of exchange announcements – Frequently release notices to the exchanges, in a bid to prop sagging sentiments or to aid momentum
    • Comment – Business managers should avoid sending press releases which don’t materially affect the company. They should be indifferent to independent external publications like: broker reports, media awards/ratings, business magazines ranking upgrade etc., instead of uploading those on exchange sites to excite investors.
  • Frequent corporate actions like hiving divisions or mergers or acquisitions etc – Hive off / demerge an existing division of the company with an intent to unlock valuations by way of either listing or IPO of that division separately (main board/SME).
    • Comment – Educated investors can see through cases in which such actions are undertaken with the only intent of creating a buzz or excitement, to shore up stock prices in the garb of ‘value unlocking’. Mergers & acquisitions enable managements to hide/suppress things from investors, thanks to the combined financials of the merged companies making it difficult to analyse the numbers.
  • Preferential issuances – Raising money by placing equity to a clutch of unknown retail investors, immediately followed by a sharp spike in the stock price
    • Comment – Several historical instances of a sharp stock spike, to facilitate profit booking for preferential allotees (under aliases/friendly accounts), to fund their preferential purchase, is a very popular practice. Retail investors may be ignorant of this practice though, but educated investors can see thru’ such gimmicks
  • Capex announcements – Capacity additions are announced to signal management’s confidence on existing and future utilisation
    • Comment – Gold plating of capacities is an old and established practice for siphoning off funds. That said, instances of under invoicing capacities (under invoiced amount funded by cash payments), to display management prudence and bargaining ability while adding capacities also seems to be a popular practise to display managements ability to procure at lower prices. Amounts, so paid in cash, will get reflected elsewhere in the books and cant go undetected
  • Bonus and Stock split announcements – Announce generous bonus or stock splits to boost sentiments and/or liquidity by making the stock ‘optically’ cheaper.
    • Comment – Bonus/stock splits don’t fundamentally alter the company’s performance and hence are viewed as event neutral developments by the serious investors
  • Frequent media appearances – Frequent interviews on electronic and print media channels, to enhance investor visibility OR to talk up the stock price.
    • Comment – Experienced investors read frequent media appearances, by business managers, as advertorials. Buy-side investors rarely watch market channels for their decision making.
  • Frequent changes in KMP – KMPs change without any reasonable explanation
    • Comment – Frequent changes in KMP like CS / CFO or a company auditor, for that matter, make investors uncomfortable. Such moves stoke concerns over corporate governance issues, within the company, which may have possibly triggered their exits.

In conclusion –

Capital market is a fantastic platform to create wealth, for shareholders and promoters alike, provided promoters respect and follow the basic tenets of long term value creation. While human tendencies may often tempt business managers to relent to short term factors, their ability to stay focused on the longer-term horizon determine the success and longevity of the business.

Please be noted that the above list is not exhaustive in nature. There could be several more added to it. Should you know some such practices, feel free to update me. Happy running.

Cheers!!! Sudhir

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