The investor’s dilemma

Jayant Pai | jayant@ppfas.com

 

 

 

 

 

Minority investors in stock markets are invariably affected by actions taken either by the controlling shareholders or professional managers who are chosen by them. Many a time, the quest for profit is often preceded by actions which are inimical to the well-being of society in the longer term.  

However, as stock prices are often influenced by quarterly profit figures, minority shareholders often turn a blind eye to such egregious actions as long as their net worth is rising. Very often, investors are keen to ally with a capable management and not necessarily a honest management. This applies to both, individual as well as institutional investors.
Two such instances are :

  • Industries involving extraction or conversion of natural resources: Here it is implicitly assumed that promoters have to be adept at ‘managing the system’ (a euphemism for indulging in corrupt practices) in order to win contracts and secure favourable pricing. Managements who are proficient at this are regarded as ‘wealth creators’ and are often accorded a higher valuation as compared to those who insist on playing by the book. ‘Everyone is doing it’, ‘This is a pre-requisite for this industry’, ‘At least they are spreading the wealth around’ etc. are some of the justifications which are commonly given.
  • The financial sector:Very few regard bankers as ‘noble’. Everyone considers them as shylocks. However, that has not prevented this sector from acquiring maximum weightage in several global indices over the past decade. In the USA especially, banks have today morphed into supercharged cowboys, fuelled by leverage. They have spread their tentacles into various ‘non-core activities’ including proprietary trading, production and sale of exotic derivatives etc. This high leverage has translated into high Return-On-Equity (RoE), the mantra chanted by all shareholders.

The attendant ill-effects of indiscriminate lending and questionable accounting practices on society at large were ignored until they exploded in the face of investors in 2008-09. Surprisingly, instead of welcoming the resultant higher capital adequacy requirements, investors moaned that lower leverage would negatively impact RoE. It was therefore broadly concluded that banks deserved to be de-rated even if they were systemically safer after the changes came into effect.

So how do we reconcile the apparent dilemma between choosing what is good for us as shareholders and choosing what is good for society ? Actually, it reconciles by itself. In the short-term, sharp practices help in creating a perception of an increase in one’s wealth and well-being but it does not go on forever. Ultimately the past will catch up with such companies and will drag down all shareholders in its wake. In India, we are seeing this in sectors such as real estate, certain pockets of infrastructure, telecom, etc. Yesterdays darlings have been reduced to today’s pariahs. Many shareholders who began averaging out their purchases in 2009 have given up trying…Promoters who were adorning the lists of billionaires then, are struggling to erase their names from police records today.

Investors who feel no qualms in aligning with suspect managements or bubbly sectors must take some efforts to develop one more skill : Bailing out before the s*** hits the fan.

Leave a Comment.