How to invest in the India Stock Market where Managment Quality is a choice between Bad and Ugly

Investing in the Indian Stock Markets is like navigating your way through a minefield with innumerable instances of fraud,unethical actions and disregarding the interest of the retail investor.The SEBI which is India’s stock market regulator remains mostly toothless and a blind spectator to the whole stock market fraud schemes like pump and dump.Most of the IPO’s that come in the Indian markets are blatantly manipulated by the market operators,promoters and shady investment bankers.However SEBI has not taken any action so far which would make one speculate that the regulator is itself compromised.The pump and dump schemes continue unabated in the market which remains quite shallow despite the more than one trillion dollar capitalization.Mid cap and small cap corruptions scams happen with alarming regularity and even top MNCs defraud the retail investors using legal loopholes.

List of Various Scams Perpetrated in the Indian Stock Markets

1. Vanishing Companies – Small companies simply vanish from the stock market.They stop reporting results to the market and the investors have no way to exit as their stock stops trading as the exchange bans the company from trading.You are literally left holding scraps of paper
2. Collusion between Promoters of Companies and Big Brokers – There have been many instances when promoters and big brokers manipulate the market to ratchet up the prices of stocks with no fundamentals to speak of .The instances of the “pump and dump” are too many to enumerate
3. Accounting Scandals – While the “Satyam Scandal” is the biggest one , PWC in a recent report estimated that a very high percentage of companies resorted to accounting gimmicks.Read Satyam Computer Services scandal
4. Incestuous Dealings between private and public companies the same group – Most of the Indian family groups have a labyrinthine maze of company holdings. Most of the dealings done between these companies are to the benefit of the promoter at the expense of minority shareholders
5. Tax Frauds – Tax Frauds are dime  and dozen . They are frequent and don’t even raise much of an eyebrow.Get frequently entangled in the Indian judicial system for years.
6. News Frauds – Somebody circulates a fraudulent letter through major news media.Stock price goes up ,people in the know sell out to investors who believe authoritative news media.Read  Pyramid Saimira scam: How our business media was taken for a ride

Management Quality

Any investor will tell you that the management quality in India is pretty bad with the choice mainly restricted between Bad and Ugly.Though there are some of the better business groups and companies like Infosys,the management quality leaves a lot to be desired.This is a reflection of the general system of the country where endemic corruption is present with politicians and bureaucrats indulging in scam a day.Was interesting to read a post on TipBlog about an investor concern about the ADAG group and its various shady schemes.While TipBlog does not think that management issues should become a big issue while investing and price is the main criterion in the context of the Indian stock market,I differ.I think the quality of the management plays a big role in the long term returns of the stock.It is highly unlikely that the company stock will give you good returns as the management siphons off the profits and cash through various shenanigans.Management whose past behaviour reeks of corruption will unlikely change its behaviour in the future and might lead to catastrophic losses as well as was the case with Satyam.

Understanding Investing Risk is More Than Qualitative Assessment

I would like to know about your thought process regarding your position in reliance capital (because this position was not discussed in detail as other companies you normally do. the only place i could see about this company is in the post regarding holding companies).

Based on my readings so far, I understand that this company is poised in the good position to tap massive consumer savings with its vast retail distribution &marketing strategy in mutual fund and insurance business. Whatever the new scheme it launches, it does in a big way and currently its mutual fund is top in AUM. It is also a likely candidate to get banking license.

But my concern is quality of the management i.e. ADAG. when i analyzed i found the following things to be very disturbing.

1. It’s a well known fact that due to the greediness of the management to debut in the SENSEX soon after IPO, it connived with investment bankers and priced steeply. Ultimately, it ripped retail investors.
2. SEBI barred Anil Ambani and leading official of Reliance Infra and RNRL from investing in secondary market until 2012, besides imposing a charge of Rs 50 crore for settling a probe into alleged unfair market dealings by the two firms.
3. Recently I read an article on Tekelha about the wheely dealing of Reliance Com in Swan Telecom regarding 2G and really taken aback on the involvement of ADAG
4. A Reliance health insurance premium has been priced very cheap before 3 years to garner large customers. And suddenly this year they hiked the premium by 400%. In India, until recently there was no health insurance portability and hence it would be a disincentive for clients not to renew. I found this one to be bait system to lure customers.
5. It’s well known fact that all of ADAG companies are running short of cash flows. Even Reliance Com is looking to restructure its loan it took for 3G from various entities all over the world and finally he got funds from china development bank.

In all the above cases the management tries to cheat investors or customers, regulators, govt etc. My doubt is even if Reliance Capital does well and generates cash by disinvestment of its insurance business & other things; will management share with minority shareholders. Wont they look for other illegal ways to siphon out the money from this entity to other group companies which is sinking with mountains of debts? How can retail investors entrust their money to this management? or am I missing out something?

Jagadees, has great set questions about ADAG. All these concerns points to one issue, which is, management’s past history demonstrates it is not going to share profits with small retail investors. I am with you on your concerns. A simple answer to these concerns is, that’s the risk one takes.

Give me one example where company management thinks about retail investors? Where before making a decision any company will think of small retail investors like you and me. I do not believe there is any! So either you be part of it or avoid it. I choose to be part of it and swim carefully.

Having said that, I think we as retail investors need to understand what risk means to them. It is my view that risk is something that is very subjective. To me, it’s interpretations vary like finger prints. They are never same. I do not interpret risk as a qualitative matrix. That way of interpreting risk is blind. The issues about ADAG mentioned in this message regarding quality of management; is qualitative. It does not tell me anything about risk to me. It does not tell you how it will affect your wallet? Saying, there is risk because of bad quality of management; is meaningless.  That’s why I say, it is blind for decision making.

My interpretation of risk is in conjunction with the price you pay for buying your stocks. Same question, how does it affect my wallet? So, while I agree with these concerns about bad management, I tend to take one step further and understand them in numbers. This translation is, again, subjective. But at least it gives something to measure. Let us take Reliance Capital as an example.

When I pay 400 or less for Reliance Capital, I think my risk-to-returns are reduced considerably over long term. As long as my price is more than zero, risk will always exist. But when I pay more, i.e. 500 or 600 or more, I am increasing my risk-to-returns. And hence, I should not buy at 500+. Now, if I believe Reliance Capital is junk company, I would not even think of buying any shares. But I know for sure, Reliance Capital is not a junk company. But it is neither a good or great company. It is one of many.

Coming to you concerns as listed above…

• On item number (1) I do not think there is anything wrong with it. Any business owner will do what ADAG did. Get maximum possible price in a given market conditions! If I were business owner, then I would do the same. Retail investors were not forced buy into his IPO. I wrote about it in valuation of new IPO.

• On item number (2) and number (3) Well, I do not think I expect integrity or ethics from Ambani clans. My personal view is poor guy Anil is getting killed. While almost every major business family is doing these things. e.g. His elder brother is master of such willy nillys. The recent RIL-BP deal is likely to be orchestrated by his cronies in oil ministry. There are many such examples with other industrialists also… NOT that I am a fan of such behavior. Like all retail investors, I certainly despise such business dealings. But Anil Ambani he is not the only one! So I do not take that, exclusively, as a part of decision making.

• On item number (4) Don’t you see sudden jump in gas prices? Don’t you see sudden jump in food items? Don’t you see jump in real estate prices? All are completely blatant?  Again, why target Reliance Health insurance premium? The point being I try not to mix ethical business practices with my investing goals.

Recent Mid Cap and Small Cap Scandals

India’s Stock Market Regulator has been hardly proactive in cracking down on stock market manipulation except for some inefficient scolding.It has banned some companies and a stock market operator for artificially rigging up stock prices through a nefarious scheme so that the stock could placed  through QIBs at higher prices.Recently GMO,Goldman,Morgan and Fidelity got conned by a  fly by night Indian financier who managed to place $100 million of his company’s shares a hugely inflated price.A cursory due diligence by these high flying financial institutions would have shown his business model to a sham.Realty Investing in India is always a dangerous game with real estate firms involved in all sorts of corruption scandals.Akruti City whose  shares had seen a massive rise some months ago has been implicated by SEBI for  rigging up its share price with the help of a “stock market operator”

• Corruption Scandals continue to hit Indian Stocks – DB Realty,Sun TV,Spice Jet
• Indian Stock Market New Day Old Story – Promoter -> Land Scam -> Stock Plunges -> Huge Investor Loss
• Top 5 Indian Stock Market Pitfalls as Nifty falls below 200 EMA(PIN,INP,EPI,INDY)
• Another Indian Stock Market Scandal Erupts as Realty Firm Ackruti City and Broker Dangi get Banned for Rigging Share Prices
• Dangers of Indian Realty Investing – Sahara,Oberio Realty,Lavasa and DB Realty prime suspects in latest Corruption Scandal

• Even Professional Fund Managers avoid Real Estate stocks in India
• Indian Small Cap Index,ETFs (SCIF,SCIN) get Massacred by Surfeit of Scandals
• LIC Housing Finance Crashes with PSU Bank Stocks on Loan Scam in a Satyam Deja Vu
• India’s MidCap Stock Scam gets Murkier as High Flying Agri Stocks get Implicated
• On item number (5) Bunching all ADAG companies together is, again, a folly w.r.t. investing. ADAG is not a company in itself. It does not trade in equity markets. I only picked Reliance Capital because; I think it passes my equity selection metrics. Cash flow is one of them, but not the only metrics. Now, what price to pay is a different discussion. I had held Reliance Infra for a while, but I removed that one.