For years now, I've strongly advocated fundamentals-driven investing as opposed to technical or momentum-based trading. However, there's one factor in which traders have always had an upper hand over long-term investors, which is this: trading is based on numbers that are guaranteed to be the truth, while investing is based on numbers that may be the truth, or they may be lies. What I mean is that the share price that you are told is always the real one, but the financials of the company may or may not be real. In fact, the question is not of 'real' vs 'non-real' because corporate financials do not come in the two shades of black and white. Instead, they are in many shades of grey because even the best and the most transparent companies will have some secrets that would surprise shareholders were the complete truth to be known.
Almost three decades ago, when I was just starting off as an investment analyst, I had my first taste of what a sceptical insider thought of Indian corporate governance as it existed in the early 90s. I was doing some work for someone who had spent a lifetime in finance in Wall Street and because of his personal and professional background knew many of the biggest industrialists of the time. This person understood equity investing deeply in India, and yet he would only be interested in very short-term trading. When I asked him why he didn't do any real investing, he said if I knew businesses and businessmen as well as he did, I would never buy a single stock for the keeping.
That was pretty much the situation at the time. The promoters of public companies milked shareholder wealth, and that was the way it was. Over time, things improved substantially and this risk has receded to a considerable degree. It's not that people have simply become more ethical. Instead, there is the combined effect of tighter regulation, greater information flow and the realisation that for promoters focused on personal wealth, it's better to be in the field for long, rather than have a mentality of quick extraction.
However, this improvement in ethical standards and corporate governance is a continuous struggle. As the events of recent years have shown, it's always possible for promoters to pick shareholders' pockets. That's what makes the current wave of new regulations so significant. It has always been obvious to all observers that the weakest link in this whole chain was the auditor, that is, the chartered accountants and that's the link that this government is fixing. That the Modi government had decided to overhaul the ethical standards in the accounting industry was obvious as long ago as July 2017 when the PM himself delivered his famous warning speech at the ICAI's annual function.
For Indian investors, much of what used to happen is set to change now. A slew of new regulations has put the onus of verifying the truthfulness of corporate financial information on auditors, where it was always supposed to be. However, the current changes have put auditors' skin in the game and made it clear that they will suffer real, consequential damage to their own businesses if they put their signature on fabricated information.
I believe that these new regulations, coupled with the government's determination at enforcement, mark a turning point in equity investment in India. Being able to trust the audited accounts of a company implicitly is a basic requirement for a healthy capital market. Finally, India is getting that.
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