Widely read:
When you were a school student, did you know any kids who would doctor their report cards? Nowadays, everything is online and SMS based, 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, there were two opportunities to cook the books. 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 and doctoring the marks certainly did that.
Same is the case with many listed companies. Taking the analogy further, their 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 specific goals but those goals have no alignment with the interest of the ordinary shareholder.
Over the decades, 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 course, it's only 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. In fact, the longevity of the fraud was a real wonder. As one would expect, this was possible only because of the role played by the auditors. It's befitting that the Satyam affair has proven to be a strong trigger for the audit reforms that have followed.
Satyam is just one example, but there are many more companies that have blown up over the decades. ILFS, Cox & Kings, DHFL and CG Power are some names that come to mind immediately. In most of them, there were warning signs that accumulated and were visible for long periods of time. While Satyam was different in this regard, most companies are not. Compared to now, things were quite different in the 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 kinds 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 larger companies, people misjudge the business and the valuations.
It's not easy to develop such an attitude and the skills needed to support it, but there is a lot of help available online. Value Research Online has an excellent set of easy-to-use tools that can help you. 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.
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