Mumbai, December 21: For any investor to invest in a company, “Management Integrity” and its due diligence are sacrosanct before taking any informed decision with respect to investing in that company. This was stated in Wealth Creation Study’s “Theme 2020: Management Integrity – Understanding Sharp Practices”, carried out by Motilal Oswal Financial Services (MOFS).
MOFS’s approach to equity investing is called “QGLP” – Quality, Growth, Longevity, reasonable Price, where QGL is the Value component which is then juxtaposed with P, that is, reasonable Price. As investment guru Philip Fisher has said, “In evaluating a common stock, the management is 90 per cent, the industry is 9 per cent, and all other factors are 1 per cent“.
Management integrity can be defined as dealing with all company stakeholders honestly and with a sense of trusteeship. There are two broad elements to company management – Integrity and Competence. If companies demonstrate only competence without integrity, there is enough evidence to suggest that for such stocks it’s a race to zero!
Management integrity is mainly compromised to present a favourable view of the company to the equity markets. Such attempts to “manage stock prices”, in turn, is motivated by several reasons such as raising equity capital, management compensation linked to stock prices, personal wealth enhancement, etc.
Sharp practices may be defined as “ways of behaving, especially in business, that are dishonest but not illegal.” However, once the management starts resorting to sharp practices, it’s — what Satyam Computer founder B Ramalinga Raju wrote in his fraud confession letter — “like riding a tiger, not knowing how to get off without being eaten.”
It’s important to know that there is only one right way of presenting a true and fair view of a company’s affairs and infinite ways of not doing so. Hence, examples of sharp practices mentioned here will be more illustrative than comprehensive.
Recording bogus revenue
Shifting current expenses to a future date
Recording revenue too soon
Boosting income using one-time activities
Sharp Practices during acquisitions
Taking items off-balance sheet
Management may also resort to sharp practices by way of related party transactions and also misleading earnings guidance. Other issues to monitor management integrity are auditors’ report, top management chances, promoters’ pledged shares, and a 360-degree feedback of as many stakeholders as possible – customers, employees, dealers, suppliers, even competitors.
The most important advice of the MOFS’ latest wealth creation study is that the purpose of all the above due diligence is to arrive at that moment of integrity regarding the management, before which no investment in the company should be done.