The 24th Annual Wealth Creation Study by Motilal Oswal was a good event. The toughest part of this event is to eat less at the amazing food spread! Missed Ashish of MO Mutual fund, but all the other biggies were there. Sanjoy B – was missing but Ramesh Damani and Aseem Dhru made up for his absence. For those who do not know Aseem he is a banker who has held many posts including the CEO post in Hdfc Securities – and I have heard only good things about him. I have interacted on email with him, but don’t know him personally.

My problem with this study is old. They ignore dividends – and that stuns me. The Sensex is at 44000 and the TRI is at 59000 (approx). To me this is proof that 1/3rd of the returns that a person has got is because of dividends. Well, that can wait.

The theme this year was “Management Integrity”. Basically before you read this report you should read “Accounting Shenanigans” – a basic book which every accountant should have read while doing CA or while doing audit. I do think even books like Paula De Paula on audit have some amazing examples. Well, that for another day.

Largely this wealth report is about understanding “Sharp Practices”. I have always held that Management is 90% of the choice in buying a share. However, you need to pick the right INDUSTRY first. I have had a major problem in industries like infra – I am still looking for a decent honest company in this industry. Some industries are difficult to manage. Even as the auditor or Larsen&Toubro I never mastered the stock taking and provisioning of their construction business. So even though I do agree that management is important, first the industry that you choose is far more important. Companies like auto, cement, fmcg – are far easier to talk about management integrity. Companies like hotels, hospitals, etc there is huge scope for leakage and makes it difficult for an analyst to handle. Look at the recent example – Fast tags have made NHAI a great buy – we have seen the earnings go up substantially. Controlling leakages is so important.

There is just one way of being honest – and many ways of manipulating the truth. Also you see whether a management is a big thief or a small thief. Will he commit rapes and murders or is he just a small pick-pocket. It takes a very very strong head of finance and accounts to make sure that manipulation does not happen as a routine. In accounting small slips which you allow becomes a habit and later on a disease. While doing audits of top companies one had to be alert.

Sadly most people only think of “increasing” the income as a shenanigan. Not true. I know one set of EMPLOYEES who dramatically screwed the company’s balance sheet and then went to the promoter to do a “Leveraged buy out”. Sadly the auditor did not see the games that the management team was playing. One day the promoter woke up and sacked the whole team and the company is now doing well. It is a listed company and hence I am unable to name them. I did some professional work for them, and hence the need for secrecy. If it was my own research I would have tom tom blaring!

Normally cooking up used to be something that owners did to create a good image with the bankers. However, with GST being implemented, better audits, it is becoming more difficult to manipulate. For example if a company shows a lot more profits, the banker is likely to do more audits. The employees are likely to ask for more bonuses. There is just too much of conflict among the people reading the Profit and Loss account and the Balance sheet. However, many of us have restricted ourselves to the top 100 companies and the risk is far lesser there.

However Nbfc and banks are a different ball game altogether. It was in the 1970s when the late H K Bilpodiwala (then my super boss) gave up the audit of the second biggest bank in the country. It was Bank of Baroda.

Much later – in 1983 when I asked why he had given up, I was told it was because the bank was not reconciling the investment accounts and branch accounts. As a young boy doing CA I did not understand what it meant.

When Harshad, Ketan, …frauds happened it stuck me! So knowing what can lead to shenanigans, and knowing that manipulation can be showing more (to impress capital markets), or showing less (to get more esops while keeping the price low)….reading, reading, reading, talking to vendors…helps you understand better.

A couple of incidents – I was asked to buy DLF at 1200 and I was not sure. I had not seen the balance sheet for a long time. Another problem with the balance sheet is that the accountant who creates it spends 365 days with it. The auditor spends 15 days, the analyst spends say 30 days and people like me spend 2 days (max). It is terribly against me in terms of time spent.

So I could not make up my mind about DLF. I called a friend who said “speak to this bright CA…he tracks DLF”. I spoke to him he said “at 1200 it has at least ONE DIGIT more than what I am comfortable with!! I then got the balance sheet, and was not convinced that it was a good buy AT ALL. Price did not matter. I do not like a Delhi based company that too in the construction business! So pick a good promoter, and then look at the accounts. Normally what looks like shit, smells like shit and tastes like shit is SHIT. Stick to the biggies – let the Rakesh Jhunjhunwalas and Vallabh Bhansali decide to pick the small ones. Most of us can’t.

Try indexing for starters.

Do asset management companies manipulate? yes. Accounting regulation allows a lot of discretion. So asset management companies can value debt instruments very differently from each other. Over-provisioning hurts the investor who is leaving and rewards the new investor and those who stay back. Why should a fund manager decide which investor to reward? Side-pocketing should be made compulsory – hey that is a different post!!