Ambit Research says that over the past four years accounting quality has deteriorated, the most in large-cap companies. Higher fees paid to auditors, rising debtor days and increasing contingent liabilities point to the need for investors to be on their guard
In a recent report to its clients, Ambit Research finds that in most sectors there is a direct correlation between accounting quality, share price changes and forward P/E multiples.
Here are highlights from the report.
Ambit has included 360 companies out of the BSE 500 companies in its analysis, leaving out 62 financial companies and 78 other companies that have not been listed for more than four years. It has put the 360 companies through something it calls 'revenue recognition checks', which includes CFO/EBITDA, audit fees as a percentage of revenues, and debtor days; 'expense manipulation checks', which includes depreciation as a percentage of gross block and contingent liabilities as a percentage of net worth; and 'cash pilferage checks' which involves miscellaneous expenses as a percentage of revenues, other loans and advances as a percentage of net worth, and advances recoverable in cash/kind as a percentage of revenues.
The CFO/EBITDA ratio checks a company's ability to convert EBITDA (which Ambit believes can be relatively easily manipulated) into operating cash flow (which is more difficult to manipulate). The depreciation as a percentage of gross block detects whether the company is changing its depreciation rate to report better profitability.
The reason tourism, textiles and the media score low is weak cash conversion, high miscellaneous expenses and high advances recoverable in cash/kind as a percentage of revenues.
Ambit claims that the top 50 companies by market cap in the BSE 500 had the highest decline in average annual (accounting) score over FY07-10, with the worst decline in FY10 and that, fittingly, in FY10 these companies saw the lowest share price appreciation. However, this is relative-they did perform 127% versus 146% by the next 50 by market cap, 192% by the next 50 and so on. In a bull market, mid- and small-caps do tend to outperform large-caps.
According to the report, promoters are largely behaving themselves. "The most encouraging trend is that all three 'cash pilferage' checks point in the right direction of minority shareholders. In general it appears that promoters are gradually coming to terms with the fact that withdrawing their hand from the cash register is good for their overall wealth."
In terms of the auditors, the report brings out some interesting points. "According to a report published by the Indira Gandhi Institute of Development Research, 80 per cent of Indian companies in FY07 and FY08 gave consultancy mandates to the same firm which conducted its statutory audit." This creates the possibility of a conflict of interest. Ambit finds that "companies which pay their auditors more seem to produce lower accounting scores." But one explanation of this is that smaller listed companies, who by and large tend to have lower accounting scores than larger companies, have to pay broadly a similar audit fee in absolute terms; so expressed as a percentage of their revenues, the smaller firms end up paying more than larger firms.
Housing-related companies have a weak accounting score because of poor cash generation (CFO/EBITDA is low), expense manipulation (the fall in the depreciation rate is high and provision for doubtful debts is low) and cash pilferage (loans and advances as a percentage of revenues is high); for chemicals and petrochemicals, scores are weak due to revenue manipulation (growth in audit fees is higher than growth in revenues) and expense manipulation (the fall in the depreciation rate is high), says the report.
(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife.)
New Delhi: Billionaire industrialist Mukesh Ambani is planning to provide Rs1,000 crore seed capital to kick-start a new venture that would invest in innovative business ideas, including in technology and healthcare segments, reports PTI.
Mr Ambani, who heads the country's most valued corporate entity Reliance Industries (RIL), will probably make an investment of about $250 million in his individual capacity, sources close to the development said. A RIL spokesperson did not offer any comment.
The process has begun for stringing together a team of experts with domain knowledge of various sectors for managing this private equity venture, sources said.
It said some of his close aides at RIL group might also be brought on board.
The top tier of people to be associated with this venture would include those with expertise in biotechnology, healthcare, energy and consultancy businesses, besides private equity and venture capital segments.
The new venture would mostly invest in start-ups working on innovative business ideas in sectors like biotechnology, healthcare, information technology, new and renewable energy as also traditional energy sources, among others.
However, it was unlikely that RIL group itself would get involved in the venture and it was most likely that the investment would be made by Mr Ambani in his individual capacity, sources said.
The sources said the venture would also look at roping in other investors, mostly from overseas.
He would join the likes of NR Narayan Murthy and Azim Premji—founder and chairman of two of the country's biggest IT majors Infosys and Wipro, respectively, who have floated private equity investment ventures at their individual levels.
Besides, a number of large industrial houses, such as Tatas, Aditya Birla group and Anil Ambani group have their own private equity investment arms that invest in various companies as per their respective mandates.
RIL and Mr Ambani himself have often talked about need to invest in areas like business innovation, new technology and research and development.
Earlier in 2007, RIL group firm Reliance Life Sciences had announced a partnership with MPM Capital, a US-based global investment management firm focussed on healthcare business, to invest in Indian life science sector.
Subsequent to the deal, RIL invested nearly Rs80 crore in a MPM BioVentures fund during the last fiscal 2009-10.
The group has also created a Reliance Technology Group (RTG) by consolidating various research and technology functions of its businesses.
It has also set up a Reliance Innovation Council that comprises of eminent scientist RA Mashelkar and Ambani himself, among other global leaders, from fields of science and business.
State-owned Bank of India (BoI) has hiked fixed deposit rates by up to 1% on select maturities in line with other lenders.
Term deposits of 1-2 year maturity will now fetch customers 8.25% compared to 7.5% earlier, an increase of 75 basis points, BoI informed the Bombay Stock Exchange (BSE).
At the same time, interest rate on fixed deposit with 2-3 years maturity has been increased by 1% or 100 basis points to 8.25% against existing 7.25%, it said.
However, rate of interest in other brackets remained unchanged at earlier level.
On Monday, BoI declined 4.02% to Rs461.05 on the BSE, while the benchmark closed 0.07% up at 19,981.31 points.