Invest in companies with good promoters

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used to frequently meet up with one of the most popular and successful equity investors of Mumbai, in the nineties. Apart from being an aggressive risk taker, he could form a quick picture of ‘tomorrow’ and what companies and industries could be like in the next 10 years. He had tremendous patience and also the stomach to absorb wrong calls. He was not bothered by loss of money. One difference we used to have was on promoter quality. Given my notoriously suspicious and sceptical nature, my first call would be to run

Bank Of India IDBI Bank Punjab National Bank Union Bank

SBI

HDFC Bank

ICICI Bank Kotak Bank Canara Bank

Axis Bank away from bad ones.

I recall we were discussing McDowell and Shaw Wallace. In those days, the stocks used to trade below book. The balance sheets were not great, the market reputation of the managements was terrible and the general consensus was that the accounts were suspect. The friend was busy buying blocks of shares from UTI (the go to place when you wanted to buy large blocks of illiquid shares without moving the price) and accumulating them. His logic was that these companies had great brands and the products 10.5 - 13.5 9.65 - 14.0 9.95 - 14.50 10.10-13.2 10.55 - 14.95 10.75 - 21.3 11.25 - 22.0 11.5 - 24.0 11.6 - 15.3 12.0 - 24.0 will outlive the promoters.

It was a question of patience. Of course, he was proved right. Me with my scepticism and empty pockets did precisely nothing. So, a bad promoter and a great business can be a winning combination, provided, you buy at a good price and the promoter gets out of the saddle.

The question before me is, do we find such things today? I am sure we will. Unfortunately, unlike the nineties, today the investors’ willingness to bet on anything and anyone is infinitely more. So, opportunities are fleeting and there is someone betting on every number on the roulette and most numbers will have many bets. This means that it is very difficult for someone to be the early bird. There are businesses we identify. And bet early. We are donning the hat of Capital investor.

The problem often with this approach is that the management may not change at all. Then the next bet is that the second or third generation is more tuned in to the capital markets and will do things so that the share price gets a boost. For instance, in the past, the first-generation entrepreneur lived in an era of controls and a capital market without institutional or foreign participation. He would take out as much as he could from the company and build his personal wealth. Now, things have changed. If he shows good profits and growth, the P/E multiple of the stock expands big time. Thus, a rupee not stolen gets converted into significantly higher ‘wealth’ as the market gives a higher valuation. a Venture The younger generation is aware of this and is using this strategy better. They also understand the need to keep the profits growing and meeting market expectations. They are also helped by the fact that they can pay themselves good salaries which their founders could not take. Thus, a lot of old businesses have now become ‘valuable’ businesses also. The risk one runs is that many managements give in to the goal of growing profits and resort to accounting magic to keep the illusion on.

What I notice is that in a bull market, everyone ignores promoter history and valuations touch new highs. In this noise we make the most mistakes as we are swayed by the noise. We start believing in the number ‘30’. Thirty per cent growth, 30 per cent EBITDA and sustainable for 30 years. Promoters and managements, who we are sceptical about in bear markets, become prodigal sons in bull market. We justify our investments by saying that this promoter won’t do us in as he is a changed man. Finally, they come crashing. It is just a matter of time. I have not come across tigers that have changed their stripes. The key thing when we bet on such kind of stocks is to be aware of the risk that we are taking. We are trying to ride a short and dangerous wave, hoping that the market will have enough believers in the story when we want to get out. It is very unlikely that we would like to keep such stocks in the box for our grandchildren.

My friend made a pile of money in the vice stocks after nearly two decades. He also wrote off half a dozen or more of investment calls he took. The key thing was that he never risked his all money on one stock. He was careful enough to put only so much in a single stock, that losing everything did not make a difference to his quality of sleep.

Our markets today is at an interesting spot. The proven high quality is at expensive prices. So the focus and attention have shifted to the stocks where prices have collapsed over the last one year. Believe me, it is a treasure hunt. Finding good quality promoters, whose integrity and quality have been proven, is the key to avoiding mishaps.

(The writer is a veteran investment advisor. He can be reached at balakrishnanr@gmail.com)