As a child in school, did you know any kids who would doctor their report cards? I guess everything is online and SMS-based now, but back in the day, teachers would hand out handwritten report cards which the children would take home and get signed by parents. For a child who was seriously nervous about the marks, this offered two opportunities to cook the books, so to speak. Either the marks on the report card could be modified or the parents' signatures could be forged. Many children (and even parents I guess and maybe some teachers too) had no real interest in what the numbers on the report card actually meant. All they cared about was that the appearance of good academic performance is maintained.
So it always is with many businesses that are listed on the stock markets. The promoters are like those children, with the auditors playing the role of teachers, and analysts plus investors in the role of the parents. The goal of such companies is not the underlying reality but the illusion that they generate for investors. The promoters have their goals but those goals have no alignment with the interest of the ordinary shareholder.
Historically, there have been some really notorious examples of such companies that have actually had the entire illusion blow up in the face of investors. Of such companies, it's the larger ones that catch the public eye. The largest blow-up of this kind was, of course, Satyam. Satyam was unique in two ways. One was the size of the company and its prominent role in a flourishing sunrise industry. Two, how Ramalinga Raju was able to maintain the illusion till the eleventh hour. That was the real wonder and as one would expect, the fraud was possible only because of the role of the auditors. It's befitting that the Satyam affair has proven to be a strong trigger for the audit reforms that have followed.
There are many more companies that have blown up over the decades and you can read about them in our cover story of 'Wealth Insight' August 2022 issue. In most of them, there were warning signs that accumulated and were visible for years. While Satyam was different in this regard, most companies are not. Compared to now, things were quite different in the distant past. At the heart of equity investing is the investors' ability to trust the information and the numbers that companies release about their business. Without this trust, there is nothing. Historically, till at least the 90s, it was pretty hard to trust such numbers. In fact, stock prices had what could be called a trust premium or discount. For example, there was an MNC premium, which was mostly because you could trust the numbers.
Today, for large parts of the equity markets, the situation is quite different. For at least the 100 to 200 largest companies, you can by and large trust the financial numbers. A lot of regulatory reforms of different kind have made a difference, including those in auditing as well as the web of information created under GST. Moreover, in companies beyond a certain size, the attention of a large number of investors, as well as analysts, should mean that anomalies are relatively easy to detect. However, if you are doing your own research and investing in smaller companies, then you need to know how to look after yourself. In smaller companies, people misjudge the business and the valuations.
That's where our cover story of 'Wealth Insight' August 2022 issue, as well as many of the tools that are available on Value Research Online can play a big role. Detecting potential fraud or even just spotting red flags that could possibly be questionable behaviour is an important part of the investors' toolkit.
Equity investors are optimists by nature and tend to believe everything will be fine. Most of the time that's true but when it's not true, you need to catch on early.
Suggested read: Throw caution to the winds? No!
This editorial appeared in Wealth Insight August 2022 issue. To read the cover story and other insightful analyses, columns and articles
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
