Red zone; Yellow zone or Green Zone in investing
There are a multitude of cautionary red flags present in financial statements of any company. A pretty common part of the daily grind. But the catch is, a red flag does not simply imply window dressing of accounts, artful accounting or a fraud, but red flags essentially highlight areas of concern in the financial statements, that require deep scrutiny. So by carrying out a further synthesis, investors and analysts can come to an informed conclusion, given that a solid reason is presented to eschew and neglect the concerns. One must be aware of the three primary financial statements: the profit and loss statement, balance sheet and the cash flow statement. Elements in each of these statements can fall prey to manipulation and meddling. Figures such as revenues, expenses and profits can be meddled with to display favorable margins and reflect a positive growth trajectory of the company. For instance via their tax structuring processes or debt structuring practices (which may in some cases be legal as well). The discrepancies in depreciation as per companies laws and income tax laws can be maneuvered to inflate profits. Firms that showcase a sharp deceleration in tax payment highlight areas of concerns as these practices can be utilized to inflate profits. The presence of excessive cash in the books that is not invested to generate productive income for the business say via FD or investment in liquid assets can raise a red flag amongst the investor and analyst community. Revenue recognition policies of companies can be tricky and hence a matter of concern to scrutinize. The elements that are usually prone to manipulation are namely: receivables and inventory. A significant surge in receivable days compared to revenue growth requires a detailed scrutiny to ascertain the authenticity of the revenues. Some firms may recognize revenues inflows earlier than they should report. For instance subscription service companies may recognize revenue say Rs15000 per customer for a year at once outright, than reporting Rs 1250 every month for the 12 months. If un-billed revenue is higher than billed revenue it can raise serious concerns. Hence creating an illusion of increasing revenues and profits in the income statement. In fundamental investing investors search for companies that are zero debt however if companies hold excessive debt and borrowings, that is clear point of concern. It is imperative to read notes that elaborate information mentioned in the different financial statements. Transactions to related parties like excessive remuneration or loans or sale & purchases, can be a matter of concern as profits can be distributed between known individuals and not reported in the profit and loss accounts. Some companies capitalize their expenses like R&D, interest expenses hence reducing expenses in their profit and loss statement. Such practices call for a detailed scrutiny. Suspicion should arise in the case of a rise in profits despite a decline in revenues through one off incomes. Firms that are involved in a lot of acquisitions can present misleading figures by displaying or recognizing rising revenues not from their core business but by the acquired company (that they now own). In addition exorbitantly priced acquisitions under the justification of acquiring intangibles like goodwill smacks for suspicion. Ambiguous expenses on assets such as excessive spending on computers per employee, purchase of equipment that costs higher compared to their industry counterparts or baseless CAPEX activities totally unrelated to core businesses can raise eyebrows in the analyst and investor community. Operating cash flows being significantly lower or negative compared to operating profits seems an obvious reason of suspicion and requires detailed scrutiny. There are other critical factors that raise alarm in the inventory and analyst communities such as frequent change in auditors of the companies or recurring negative comments and remarks by the auditors on the company’s financial statements. A boastful management that enjoys excessive remuneration compensations is a big no for investors as the management is not investor friendly. Abrupt exits of members of the management can raise questions. A management lacking competence will go leaps and bounds to grow their business to attract investments. They try to create an image of a business that is well done and must obtain investment to perform better though the money may go into thin air So, when do promoters or managements choose the wrong path? Where does this manipulative instinct rise from? The simple answer is: Greed and Fear. The stock market thrives on the concept of greed and fear as the transactions between buyers and sellers would not take place if they were not influenced by greed and fear. As warren buffet states be greedy when others are fearful and fearful when others are greedy. Whilst this game of greed and fear is played between investors surprisingly many promoters and managements of companies join the bandwagon to inflate their share market valuation and business valuation than rely on their knowledge, skills and talents to nurture their company to organically obtain the high prices and market cap. Promoters are influenced by greed to increase the stockmarket valuation (short term view) in the market. Ignoring the miracles of long-term growth by expanding business operations through reinvestment of earnings and increasing operational productivity, leading to rising revenues and profits eventually translating in their rising earnings and higher business valuation. A more justified way to expand the value of the business. Clearly the best path to follow. Some promoters may fall prey to greed to perform better than their competitors in terms of market capitalization of their companies and resort to unhealthy accounting practices deceiving investors. Ego clash with self for promoters can lead to unhealthy thoughts if unable to meet promised targets they announced publicly. Fear of loss in reputation may haunt them to take the wrong path however this loss in reputation would be short lived v/s loss in reputation that can take place on a larger scale by following wrong accounting practices. Hence promoters shall have the ability to accept their mistakes, accept the fact that a decline in performance is short lived and they can bounce back as every business has a cycle of growth. Promoters and managements that are under pressure to maintain high growth can get misguided to take the wrong steps. Firms that frequently raise money can raise red flags hinting at wrong doings/ wrong capital deployment by the management for their benefit. All
Indian Economy = stirring a recipe to become the world’s third largest economy
As we swift through history, we reckon that every country/nation undergoes dramatic cycles of prosperity establishing themselves as a superpower/developed country.AND… this cycle continues to revolve over and over time. Who were once leaders would now be struggling and who were struggling would now be thriving, synonymous to the karmic cycle. Post WWII America emerged as the superpower of the 21stcentury replacing Russia. Japan was too once a superpower thanks to their superior innovation standards that were a benchmark of supremacy in the field of innovation. Within about three decades China has witnessed metamorphic changes, promoting itself from a developing economy to almost a developed economy. Next in the race stands India, bolstered by a strong foundation that has been a work in progress since the last decade. It is possibly on the verge of an inflection point of growth as one of the world’s largest economies, a successor to China and the US. The current geopolitical situations have rendered a new world order and India is one such country that is believed to gain from the new developments. Going back to the 2000s As globalization flared across the world, India was acknowledged as a nation that had access to rich and resourceful skilled labour pool that was educated, avid English speakers and did not demand heaps of salary v/s their Western counterparts. This gave a rise to India as a nation that specialized in offering a gamut of IT services. BUT TODAY… India seeks to position itself as a manufacturing and export partner to the world, offering the China+1 benefit to the world. India is believed to be one of the strongest contenders for friend shoring purposes as nations around the world diversifytheir supply chain and manufacturing partners away from China. India is touted to become the office and factory of the world in the coming years due to a plethora of reasons. As a nation, India had taken strides within the last decade with its multifarious initiatives towards development of the economy to boost productivity in of all areas of the economy. Let’s see what have a deeper look at these developments. The development of the India Stack, a digital infrastructurereinstates India’s response to leveraging technology to algin and streamline multiple activities (Aadhar identifications, to payment of bills, to eKYC’s etc) for easy access to various records and documents. India Stack has stimulated digital as well as financial inclusion for the Indian population (Jan Dhan; OCEN). SME’s and MSME’s that attained survival of the fittest post introduction of GST are provided with access to creditfacilities to catapult productivity and growth of businesses, in turn boosting the Indian economy! India has geared itself towards catapulting its infrastructural activities via increased public and private partnership led CAPEX spending on physical infrastructure (expansion of roads, railways, ports, airways), industrial/ institutional andresidential infrastructure since the last few years, propelled by schemes like NIP, PM Gati Shakti , ULIP and NaBFID. They aspire to build connectivity between states of the country, between ports and railways, ports and airways, roads to railway and all to warehouse facilities in order to enforce seamless logistics (with access to real time data for efficient and productive decision making regarding infrastructural developments) with the mission of reducing their excessively high logistics costs (NLP initiative). All these initiatives are likely to impel employment astronomically leading to increased customer demand and spending, supporting the economy. In totality, India envisions itself as a nation that seeks to leverage technology as its backbone in order to proliferate connection, standardization and formalization between alleconomic activities! A creation of an entire ecosystem that is interconnected to nurture a sustainable and self-sustaining economic activity. India is bolstering industries (private companies) towards achieving manufacturing growth and self-dependence by offering incentives via their PLI scheme, amplifying the Make in India initiative. Around a mix of 15 sectors are being sponsored by the PLI scheme such as telecommunication (to make India 5G friendly), semi-conductors, solar modules,mobile phone, electronics, automobiles, pharmaceuticals,pharma APIs, IT hardware and products and much more. Public capex is also directed towards the telecom industry, defense industry and manufacturing to achieve self-sufficiency as a nation as well as bolstering their export market via FTAs thanks to support from private sector capex. This initiative advocates the creation of productive economic activity, stimulating both public, private and FDI investments towards development of sectors, industries and eventually the economy. With the ease in regulations and land related regulations and processes, the government seek to encourageFDI inflows for development and creation of a manufacturing hub unique to India via FTAs. The ONDC scheme seeks to abolish the monopolies of giant e-commerce players by inviting SMEs and MSME’s in the market, equipping them with an opportunity to compete alongside the giants and incumbents. India is home to the largest youthful population (major consumer market) today,that is connected to the internet and avid users of technology.The government is promoting skilling initiatives for digital inclusion of deprived youthful population to make them ready for the digital job market. Hence providing the world with skilled employees and a resourceful labour market. In addition India is very serious towards climate change and seeks to reduce its dependence on fossil fuel based energy. They are aggressively investing in creating an infrastructure and building extensive capacities to kickstart energy generation from renewable energy resources such as solar power, wind power and a potentially awaited hydrogen basedenergy generation. An increase in energy generation from renewable energy will lead to a plunge in the country’s trade deficit as its reliance on oil and gas will decline. Hence the funds can be deployed in the economy towards efficient businesses practices to boost the economy. India seeks to become net- zero by 2070, decelerate its emission by 45% by 2030 and generate 50% power from non- fossil fuel-basedresources. One thing is for sure, India has embarked on a journey, towards creating an ecosystem, stimulating business activity,so they can contribute their share towards the ultimate development of the economy. In addition India is leveraging its youthful population base to achieve productivity and efficiency to achieve India’s economic mission and vision. Thus, ultimately helping India to attain the position of the third largest economy in the world in the coming years. India is truly developing itself as market that has the potential toflourish, given the opportunities for the potential wealth creation by public and private companies once their investments in developing the country materialize. Surely everyone will want to get a slice of this market. Disclaimer: The opinions expressed within this article are personal opinions of the author. The facts and opinions appearing in the article are views of the author in general and the author does not hold any legal responsibility or liability for the same.)
