Watch Out for Bottomless Pits

A shareholder-friendly management?

Forget about it.

Very difficult to find, nowadays.

Gone are the days where you’d see an Azim Premji driving his 800, or a Narayana Murthy travelling economy class.

These legends believed in increasing the shareholder’s pie. And this they did, big time. Ask any Wipro or Infosys shareholder. These legends were very clear about one thing: there was no question of pumping in useless expenditure into their public limited company at the cost of the shareholder.

The norm, btw, is totally opposite. Public limited company managements live it up at the cost of the shareholder. Very few promoters are actually bothered about their shareholders. It is the norm to put medical bills, day to day living / wining / dining / entertainment costs, personal property purchases etc. into the company. Why should the promoter bear such costs when there is the public limited company to put these and such costs into? Logical?

Don’t expect too much from your average promoter. He’s not in the game for you.

Where does all this leave you, by the way?

Firstly, you need to look out for, and avoid bottomless pits. These are companies that bear huge amounts of expenditure emanating from the whims and fancies of the promoter. For example, the total sports sponsorship bill for Kingfisher Airlines is staggering. Then there’s this huge red flag in their balance sheet – the company is in under a mountain of debt. On top of that, this company just reported almost a 100 million USD Q2 loss. Math doesn’t add up for you to be investing in such bottomless pits, does it?

In your search for idealistic and shareholder-friendly managements, you might come up with a handful of names. Next you’ll find that it’s no secret. If there’s an idealistic and shareholder-friendly promoter around, people can see this in his or her deeds and of course in the balance sheet of his or her company. Savvy early investors make a beeline for such companies, with the result that by the time you get there, the concerned share-price is already quite inflated. You’ve identified a good investment, but you are not going to enter at an expensive price. If you do, you’ll not be able to sit on your investment for the long-term. Even slight volatility will shake you out of it.

Instead, you choose to wait for the right price to arrive, and then you enter. Well played.

The deal is, that more than 90% – 95% of managements don’t play it like an Azim Premji, or a Narayana Murthy, or an Anu Aga for that matter. However, shareholder-unfriendly promoters sometimes own companies that are lucrative investments. This can be due to niche, cycles, technology, crowd mentality, whatever. When do you buy into such companies?

As a long-term investor, you wanna be buying such companies at a deep discount to real value. My thumb-rule is a single-digit price to earnings ratio. You can have your own thumb-rule. You might have to wait a long time to get this kind of a price, but that’s what long-term investing is about.

As a trader, you buy into such a company with the momentum. You can buy after a resistance is broken. Or after a high is taken out. Or upon a substantial dip after the first burst of momentum. As a trader, what is far more important for you is to know when to let such a company go. Know the level by heart below which or at which you will exit such a company. In trading, exits are far more important than entries.

The mistake you don’t want to be making is to invest in a bottomless-pit, no matter how cheap the share price is.

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