The Stakeholders Not The Shareholders

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I have always asked myself “ Whether Good Economics makes for Good Profits”. Having graduated from college, I viewed the marketplace as rational. Suppose A company is trading at 100 rs and has an eps of 50 rs, the market would have assigned a PE of 2, I would normally assume that if the company’s eps is 100rs, the share would automatically trade at 200 Rs. How did  I know anything about bull and bear markets?

The answer is a resounding yes or no. As with the evolution of the human species, the answer lies in the middle. How did I miss this?

I have always wondered why we were not taught the importance of customer in the marketplace in school. As Gandhiji considered Commerce without Conscience as one of the seven sins. Why have companies invested billions of dollars to automate their processes, trust in systems over man has led us to a point of where we have made employees lose their contact with the customer. They live in cubicles and have no contact with the real world.

Nowhere is this more illustrated than by Wall Street imagining creating wealth by slicing and dicing mortgage securities and repackaging and selling them. The whole crux of this issue was lost in the first place by lending money to Ninjas (No income, No job and No assets) rather than Dinko (Double income, no kids). The financial sector drove the real world than the real world driving the financial world. The Global GDP is 50 trillion and derivatives is 7 times of this amount. Thanks to this, we are not able to accurately predict the direction of the market by looking at fundamentals. Nowhere is this more illustrated than the yen carry trade where interest rates in Japan were 1 % and in the case of New Zealand where interest rates were more. The interest rate parity theory would suggest where the arbitrage opportunities exist the exchange rates would have to weaken in Japan but it did not happen for a long time. We have PE’s and hedge funds which are unregulated and Wall Street says regulation would stifle innovation. Haven’t we seen enough innovation?. Joseph Stiglitz goes a point further by suggesting derivatives be banned.

  In this time and age, it has become even more apparent that though fundamentals are ceasing to matter, there is an increased need for us to repose faith in Ben Graham and other value investors. As I have said earlier, the capitalistic system has evolved from the promoter’s perspectives, to the shareholder’s perspective to now stakeholders. Example; JSW steel will be issuing shares to tribals in West Bengal who are going to be dislocated by the project. I as a shareholder will be put out of business in a matter of 2-3 decades. I am none the happier, though I will make less money atleast I will be living in a world with less-disparities. The propensity to acquire bigger car, bigger house, greed at any cost, disregard corporate governance by Satyam and many others would gradually make it’s way out.

 There are super investors like Warren Buffett and trader cum investors like Rakesh JhunJhunwala who were probably born at the right time and were at the right place. Investors cannot duplicate them, reasonable profits can be made. Most of the companies have new competitors entering at the drop of a hat, and markets are complex and volatile where even fundamentals cannot guarantee you success. All the more reason to look at fundamentals.

Let us take a look at the economics of a few sectors:

Media and Entertainment and Insurance sector: the sector has become a circus with many entering. LIC had a 98% claims record which more than meets the global standards. What are these companies going to do? I have no clue!
I attended a job interview in a telecom company dabbling in insurance for Sales. They were offering 20,000 Rupees for every 1 Lakh for every client secured. The fundamentals have gone for a toss! The motto like in the Media and Entertainment seems to be secure business at any cost. Nowhere it is more evident than Media and DTH where companies are bleeding because companies want to secure market share. It is naïve to think that these companies at some point of time would be able to price their way out by having loyal customers at some point in the future.

Companies are supposed to make rational capital allocations but you cannot expect it from TV18. They have supposedly paid hundreds of crores to Rajdeep Sardesai to retain him. The only thing I noticed he spits at everybody he interviews. Diversifying into unrelated areas like email service.

 Banking- This is the sector that one needs to put money in. Eventhough we assume it is commoditized with too many players yet it still has profitability. Although the reluctance of the banks to take risks, not lend to SME’s, playing safe by lending to capital intensive companies can be faulted, as an investor the economics is sound.

As I look at all the sectors and the companies look at a top-down evaluation. We had the pharma sector which was promised 40 billion in opportunities once the patents expire. Little did one realize that the price at which a drug is sold pre and post patents is a tenth of the price. What 40 billion?. Then we have the small companies emerging in the pharma sector. How are they getting the margins? Cutting corners by disregarding manufacturing quality is the only answer presumed by me. You have the same sales representatives as the big companies, the costs are the same. India has probably 30% of fake quality medicines according to estimates.

As we survey the horizon, we are promised untold millions by investing in jatropha and ethanol. One is where you take out the land growing crops and plant this crop. It will make you rich! They tell us. Sure I would like have jatropha as my staple food. The other is a byproduct in the Sugar sector. Convert all the land and let it grow sugarcane and we shall have ethanol.

In short, commodities have bad economics, because of lack of entry barriers and lack of any type of differentiation by the companies.

I shall continue to think about the subject but the sectors where one would safely assume there is growth and value is Infrastructure, Banking and Retail.