Proactive Investors Can Boost Value Creation

While throwing some light on value creation in India, K R Choksey says that if the government manages the growth of the economy well by implementing the right policies, better growth can be achieved and will thus enhance value creation in the country.

• If quality of management of the Indian companies improves, there is good chance of capital formation along with capital creation.
• My worry is regarding large financial institutional investors who invest huge amounts in some companies but never question the management even if the company is not doing well.
• If money is invested in good value companies in falling markets; the opportunity for value creation is higher.

Speaking of value creation, it is a good corporate performance that ultimately results in value creation. Value is created by a combination of factors. The management’s commitment to growth, right and innovative technology and strong finances make a ground for decent value creation. Apart from this, the business of the company needs to be looked at. If there is a potential in the business, only then is value creation possible.

Considering India, the economy has witnessed a good growth but only a few companies have created real value for investors. We can rather count them off hand.

We need to find out the reason for this difference that exists despite a level playing field. The answer is quite simple, if we look at the companies that have created value and the other lot that has not, one thing emerges clearly. It is the willingness and quality of promoters who are responsible for this. The ones who have failed are due to their promoter or management strength and poor management quality. I personally feel that if quality of management of the Indian companies improves, there is good chance of capital formation along with capital creation.
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Another important factor is awareness about the equity markets as a whole. If we take a keen look at companies that have created value for investors, many multinational companies (MNCs) which were bought by George Fernandez (Industry Minister in 1977) decades ago, and were asked to be listed on the Indian bourses. Then there was a good opportunity. Just imagine the likes of HUL being traded at just Rs 2.5 premium to face value. Even we have purchased Ponds for Rs 17-18. However, back then there was no awareness about the equity markets as such. These companies with a good management and a decent technology created value for investors. These companies helped in boosting confidence that money can be minted in the equity markets.

Another important aspect here is that new types of products are being offered by the exchanges. These products provide a lot of leverage and are therefore usually preferred. But I feel that while this derivative segment is providing liquidity to the markets, it is not helping the markets. The reason being, price fluctuation in the derivative market takes place on mere demand and supply factors and not on fundamental factors.

As the cash segment and derivative segment are related, the impact of fluctuation appears in both these segments. I believe that if the derivative market is avoided, the value creation opportunity would be much larger. Ultimately, they are not making money as even a single negative event or a wrong move results in the erosion of capital. Further, the investors are highly leveraged here hence even losses are quite high. Very few are lucky to make money in such a fashion. On an average, investors have made more capital than those who trade in the speculative derivative markets. I am not saying these are bad, but these are hedging products and should therefore be used for hedging rather than speculating.

Another facet of this is the contribution of dividends in value creation. One must understand that returns are generated in two ways - dividend distributed by the companies and capital appreciation. Both aspects are important and have their own space in value creation. Naturally, capital appreciation is favoured more than dividends. For instance, if a company is not declaring dividends and is reinvesting in business, there would naturally be an appreciation.

One such company is MRF; the capital of the company has remained stable for the past many years. However, despite higher earnings, the company has not paid dividends. But the market cap of the company has increased, thus helping generate greater returns. Though they are not distributing tax, they are reinvesting, they have the best of technologies. But there are many others, like MERC which has higher earnings (EPS Rs 47), with a strong cash of Rs 189 crore on the balance sheet and paying a mere dividend of Rs 2.50. The company has not been investing in the business either. This clearly shows that the management has no intentions of sharing the wealth with their shareholders. A noticeable part is that more than 10 per cent holding in this is with large institutional investors. But they do not ask question the management.
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So my worry is regarding large financial institutional investors like GIC, LIC etc, who invest huge amounts in such companies but never question the management even if the company is not doing well. If they are not concerned, who is going to listen to minor shareholders? I feel they have to be proactive to protect small investors’ money, which is not happening and is hindering value creation.

Foreign investors have also played an active part in value creation. Though it is hot money, they have helped the markets grow. FIIs have helped on many fronts like foreign exchange position and most importantly, they have created a lot of liquidity. Further, some of the good companies even got to raise funds this way. Hence it has been a big positive. But ultimately it is hot money; they can go back at an even faster rate than they have come. They are simply interested in making money.

One question is about whether old economy stocks are good or new stocks. My understanding is that it is not about old stocks or new. It is all about investing in a company where you understand the business, where you can foresee if the business is growing. On the growth front, try to see if the company is growing at the rate of 15-20 per cent as the theory of compounding applies here. But when it comes to some new companies creating value, there are issues about companies tapping the primary market floor. There is hardly anything kept on the table for the retail investors. I am not saying investment in an IPO is not good, one can discover value in IPOs also if proper caution is applied.

Another worrying factor is the mentality of many running away when the market is down. Rather, that is the time to invest. When indices decline, the value increases as the risk part is reduced. But most of the investors do the exact opposite. If money is invested in good value companies in falling markets; the opportunity for value creation is higher. These days, everyone wants to earn money, but value-based investment theory is the most successful. Always try to understand the value. There are good companies, but one must ask themselves “at what price are they good?’

In a nutshell, one thing which is good at one price may not be good at another price. The best way is to invest in a small way and built your conviction.

Looking into the future, the Indian economy is growing and hence every sector is growing. However, if the government manages the growth of the economy well by implementing the right policies, better growth can be achieved. In India, the market cap to GDP is still lower and hence there seems to be quite some space to work on this front. According to me, the Indian economy is at a very low ground. What is the biggest advantage for it is that there is domestic growth and consumption. The proper management of the economy is required along with curbing corruption.