Capital Markets are reformers. As more and more people realise it, the game changes. If I go back in time till the early nineties, valuations were very moderate. Interest rates were in their mid to high teens. And given licensing and corruption, company growth rates were modest. We also had a set of archaic rules where even a promoter could pay himself a salary that was limited by law. Our economy had the proverbial “Hindu” rate of growth. Agriculture was two thirds of the economy. Services were not an officially recognized sector to make a dent.
This naturally meant that there was a big incentive for a promoter to siphon off money from the company. Stock markets were so archaic that a government babu who worked on a book value formula fixed the maximum retail price (MRP) of a share. Thus, a good company had no incentive to issue shares. Many companies got listed merely for tax reasons. Shares in a private limited company were subjected to ‘wealth’ tax whereas shares in a listed company were not. So many good companies got listed. However, they made sure that application forms were distributed to select groups. Thus, we see that many promoters had holdings between 50% and 90% or more.
This sarakari babu also helped in creating immense wealth when he forced companies like Colgate or Lever to issue shares to Indian public based on their formula. If you got 100 shares of Colgate Palmolive at the issue price of Rs26 (face value Rs10) in 1978 in an initial public offering (IPO) that was like the Sikkim Lottery. In the first two years, you would have got dividends and bonuses that would have made the shares free and by now, you would perhaps be owning close to a lakh shares! That is, provided you did not sell out. Hundreds of similar ‘investors’ probably held on, but there were thousands who sold out too soon. Very few investors actually followed the secondary markets and made it big.
Promoter wealth creation had to depend more on siphoning money out of the company rather than by building wealth with the company. The cruel tax structure plus the wretched state of the capital markets led to this promoter behaviour. Greed is dormant in all humans. Capital markets brought this alive.
Then came liberalization. And the abolishment of the MRP system for share issuances led to a new paradigm. In trooped the institutional investors with their knowledge about valuation, and research reports. A liberalised economy brought in with it a flood of capital that also structurally brought down the interest rates. And the government also removed irritants like ceiling on management salaries.
Now, the promoter started to think differently. He realised that a rupee of additional earnings per share (EPS) meant crores added to his tax-free wealth. So, stealing from the company was not as remunerative. Of course, there are many whose deoxyribonucleic acid (DNA) cannot change. The next generation is as smart or smarter than their parents. They also have the advantage of an open economy and knowledge about capital markets. They know that it is important to show as much earnings as possible, so that the share prices remain high. And yes, one can play games with shares. Private placements, qualified institutional placement (QIP) issuances, and non-disclosure of promoter holdings in full are part of a new game.
The present generation is clued in on the capital markets. So if you think the DNA has changed, think again. It does not. The gene is the same, but the manifestations are different. The entrepreneur dresses up his business to present a façade of attractiveness.
I now see a breed of young investors falling easy prey. The young investor is brash and their crowd is large enough to create a short-term ‘self-fulfilling’ prophecies when it comes to share prices of small companies. Gen-next is sharp. They know the key to riches lies in the capital markets. And they have ready accomplice - investment bankers hungry for fees, institutional investors with other peoples’ money and brokers who know how to lure investors to stocks, no matter how bad. The stock markets are a magnet that draws every participant in to its folds.
As a fly on the wall, there are a few things that strike me. One is that the entrepreneur is as sharp as he was. No one can mess with him. Investor is more aggressive, but more gullible. The regulator has left the field open. Like the Keystone Cops, they will provide the laughs in the end.
Let me close this out with the story of a commodity-based company from Western India. In the 80s and 90s, the earnings used to stagnate. The promoter did not like paying excise duties so most sales proceeds used to be pocketed. Earnings would always disappoint. Today, newspapers talk about ‘re-rating of the company. The second generation is in control. They have spared no effort to shore up the earnings. And now they spew management jargons. They are now considered as a ‘retail’ brand. Over the decades, public awareness of the brand has been high. But now, the analysts and fund managers are becoming aware of this brand. They believe that the ‘brand’ getting more reach because of advertising campaigns. The analysts, if they go beyond their top line and bottom line growth, will find out the true growth story. However, they are now busy planning their investment in a QIP. Once the QIP happens, the cash will go out of the company and then the stock would perhaps become a ‘bargain’. Information age? You decide for yourself. Yes, you get a lot of information. But that one piece of right information will not come your way. You have to go dig for it.