Understanding Investing Risk is More Than Qualitative Assessment

I love to interact with readers when they write a good thought based message. I like their questions, specifically, when they would like to discuss investing related questions. One of TIPBlog’s reader, Jagadees, wanted to know my thoughts on generalized qualitative risk assessment in the context of my buying Reliance Capital shares. Below is his mail message.

I would like to know about your thought process regarding your position in reliance capital (because this position was not discussed in detail as other companies you normally do. the only place i could see about this company is in the post regarding holding companies).

Based on my readings so far, I understand that this company is poised in the good position to tap massive consumer savings with its vast retail distribution &marketing strategy in mutual fund and insurance business. Whatever the new scheme it launches, it does in a big way and currently its mutual fund is top in AUM. It is also a likely candidate to get banking license.

 

But my concern is quality of the management i.e. ADAG. when i analyzed i found the following things to be very disturbing.

  1. It’s a well known fact that due to the greediness of the management to debut in the SENSEX soon after IPO, it connived with investment bankers and priced steeply. Ultimately, it ripped retail investors.
  2. SEBI barred Anil Ambani and leading official of Reliance Infra and RNRL from investing in secondary market until 2012, besides imposing a charge of Rs 50 crore for settling a probe into alleged unfair market dealings by the two firms.
  3. Recently I read an article on Tekelha about the wheely dealing of Reliance Com in Swan Telecom regarding 2G and really taken aback on the involvement of ADAG
  4. A Reliance health insurance premium has been priced very cheap before 3 years to garner large customers. And suddenly this year they hiked the premium by 400%. In India, until recently there was no health insurance portability and hence it would be a disincentive for clients not to renew. I found this one to be bait system to lure customers.
  5. It’s well known fact that all of ADAG companies are running short of cash flows. Even Reliance Com is looking to restructure its loan it took for 3G from various entities all over the world and finally he got funds from china development bank.

In all the above cases the management tries to cheat investors or customers, regulators, govt etc. My doubt is even if Reliance Capital does well and generates cash by disinvestment of its insurance business & other things; will management share with minority shareholders. Wont they look for other illegal ways to siphon out the money from this entity to other group companies which is sinking with mountains of debts? How can retail investors entrust their money to this management? or am I missing out something?

 

Jagadees, has great set questions about ADAG. All these concerns points to one issue, which is, management’s past history demonstrates it is not going to share profits with small retail investors. I am with you on your concerns. A simple answer to these concerns is, that’s the risk one takes.

 

Give me one example where company management thinks about retail investors? Where before making a decision any company will think of small retail investors like you and me. I do not believe there is any! So either you be part of it or avoid it. I choose to be part of it and swim carefully.

 

Having said that, I think we as retail investors need to understand what risk means to them. It is my view that risk is something that is very subjective. To me, it’s interpretations vary like finger prints. They are never same. I do not interpret risk as a qualitative matrix. That way of interpreting risk is blind. The issues about ADAG mentioned in this message regarding quality of management; is qualitative. It does not tell me anything about risk to me. It does not tell you how it will affect your wallet? Saying, there is risk because of bad quality of management; is meaningless.  That’s why I say, it is blind for decision making.

 

My interpretation of risk is in conjunction with the price you pay for buying your stocks. Same question, how does it affect my wallet? So, while I agree with these concerns about bad management, I tend to take one step further and understand them in numbers. This translation is, again, subjective. But at least it gives something to measure. Let us take Reliance Capital as an example.

When I pay 400 or less for Reliance Capital, I think my risk-to-returns are reduced considerably over long term. As long as my price is more than zero, risk will always exist. But when I pay more, i.e. 500 or 600 or more, I am increasing my risk-to-returns. And hence, I should not buy at 500+. Now, if I believe Reliance Capital is junk company, I would not even think of buying any shares. But I know for sure, Reliance Capital is not a junk company. But it is neither a good or great company. It is one of many.

 

Coming to you concerns as listed above…

  • On item number (1) I do not think there is anything wrong with it. Any business owner will do what ADAG did. Get maximum possible price in a given market conditions! If I were business owner, then I would do the same. Retail investors were not forced buy into his IPO. I wrote about it in valuation of new IPO.

  • On item number (2) and number (3) Well, I do not think I expect integrity or ethics from Ambani clans. My personal view is poor guy Anil is getting killed. While almost every major business family is doing these things. e.g. His elder brother is master of such willy nillys. The recent RIL-BP deal is likely to be orchestrated by his cronies in oil ministry. There are many such examples with other industrialists also… NOT that I am a fan of such behavior. Like all retail investors, I certainly despise such business dealings. But Anil Ambani he is not the only one! So I do not take that, exclusively, as a part of decision making.

  • On item number (4) Don’t you see sudden jump in gas prices? Don’t you see sudden jump in food items? Don’t you see jump in real estate prices? All are completely blatant?  Again, why target Reliance Health insurance premium? The point being I try not to mix ethical business practices with my investing goals.

  • On item number (5) Bunching all ADAG companies together is, again, a folly w.r.t. investing. ADAG is not a company in itself. It does not trade in equity markets. I only picked Reliance Capital because; I think it passes my equity selection metrics. Cash flow is one of them, but not the only metrics. Now, what price to pay is a different discussion. I had held Reliance Infra for a while, but I removed that one.

 

I am not justifying ADAG, Reliance Capital’s, or any other business’ practices. I am not qualified to do that. On the other hand, if I start making decision on ethical practices, there would be no company left in India or I will not be able to live my life. Question that I need to answer is, whether I as retail investor will make money by buying shares of this company – and depending upon what price I buy shares, I take that risk. Another example of interpreting risk in empirical numbers is here on expected returns of NIFTY index.










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19 Responses to “Understanding Investing Risk is More Than Qualitative Assessment”

  1. Chetan Sadanand Raut says:

    Nice to see you back again.

    Thanx,
    Chetan Sadanand Raut

  2. Govind Gadiyar says:

    Dear All,

    My response to this is as follows.

    Each one of us needs to have an investment philosophy. Then try to understand the investment philosophy of the company you are investing and also most important is to figure out the ‘Character’ or ‘Niyat’ of the business group.

    Discuss these issues with your friends and Tipblog and one gets better perspective in order to make a good decision. Also, try to meet and speak to employees and ex-employees of the company without disclosing our intention.

    • TIP Guy says:

      Hello Govind,

      Very well said on investment philosophy. I believe everybody starts with a philosophy but there are very few who have guts to stick with it. Most of us will jump at any given and/or perceived opportunity (even at the cost of violating our own philosophy).

      In addition, I am not sure about “… meet and speak with employee…..”. In the context of my investing environment, it is my belief that using it as a metric has relatively more downside than upside. This metric is much more suited to private equity type of investments.

      Best Wishes,

  3. Jagadees says:

    Hi,
    Nice to see your post after long hiatus. My learning: “Have an open mind in evaluating the business and its returns&risk ultimately depends on the price you paid”. Thanks for your insight.

    Regards
    Jagadees

  4. Pavan Kulkarni says:

    I disagree completely with this post! My perspective is that if the management of a company is crooked there is no way the investors can survive for long! Sooner or later the investors would realize it and dump the stock! If one is investing for long term it is very important to remember that one is investing in a business; not just its stock! So price to return is just one aspect of it.

    BTW, good managements are quite a few in our world (like Infosys, ITC etc)

    Ofcourse you are correct is saying that everyone’s views are their perspectives. So it is mine! I never invest with crooked managements (atleast those I’m aware of)

    • TIP Guy says:

      Hello Pavan,

      I respect your thought process and appreciate you sharing with all of us here. There is no absolute right or absolute wrong – right or wrong depends upon the context. I am sure, the context or objective lenses you are looking through, your thought process is the right way.

      The only difference I believe is my objective/lenses are probably different than yours.

      Since you brought up the example of Infosys and ITC… again it is the lenses which decide right or wrong. Infosys syndrome has killed innovation – given rise to service industry. While on one side it has generate employment (supporters), on the other hand its effect has rubbed on others, and has practically killed innovation (naysayers). Same goes with ITC…. ask a person who has lost loved ones to smoking (naysayers) and ask someone who has made money with ITC (supporters). I know ITC is more than tobacco, but the point being, it’s the lenses that make the difference.

      Best Wishes,

  5. Chetan S. Raut says:

    Hi Tip guy,
    here I am disagree with you abt right or wrong decided on the basis of context..because few things are always rights in all context..like ethics…..and u cant compromise on this…talking abt ITC we know it is tobacco company…but considering how they do business..they very honest to there share holders..and although they doing tobacco business..they doing it legally…

    Thanx,
    Chetan sadanand Raut

    • TIP Guy says:

      Hello Chetan,

      It is OK for you to disagree with me. Nothing wrong in it. I respect difference in opinion.

      But when we say, “we cannot compromise on ethics”…. its like ‘sau chuhe khakar billi haj ko chali’. Selective amnesia?

      regarding ITC…. let us keep ethics and legal separate. All ethical stuff is not necessarily legal – One can be un-ethical and still remain within legally acceptable framework. In general (but not always), ethical is associated with voluntary behavior (not bound to anything), while legal is forced upon you (one has to operate in legal environment). Of course, un-ethical stuff is frowned upon – but…… let’s stop here!

      Best Wishes,

  6. vikrant says:

    Hello Sir,

    Just one small query.. You mentioned that buying this company at 500+ would increase risk to return. and at 400 or less it reduces. I am not sure but i read in your blog that a company is good at 12 or less PE not necessary that PE is always the Metric that one should follow, however even at 500+ the company has a PE of 63, EPS of 8.19 and Price to Book 1.85, what are the parameters that makes this company a good buy below 500?

    Also like you have done the analysis of other companies are you planning to analyse this one and post it, Lastly you had mentioned that you will post your analysis of SJVN, when will we see it?

    I know you have been very busy with the new one, just wanted to know if we would see this in near term?

  7. Hemant says:

    Hi Sir,

    Here is my blog where I updated some value based recommendations -

    http://indiavaluestock.blogspot.com/

    Please visit and share your feedback.

    Thanks,
    Hemant

  8. Virag says:

    Hello Sir,

    I have only 1 questions?

    Where are you since last 5 months?

    Come back with some new…………

  9. Chinku says:

    Hi,
    Interesting debate on Quality of Management.
    For any investors who wants to invest for medium to long term (atleast 2 years) the Quality of Management is highly critical. Buying a cheap stock with poor management is bad even if it is part of a popular family, group, etc. Even gurus like Warren Buffet stress on the quality of management and governance. If this these are missing, then Buffet will not bother about the financial ratios or math.

    Keeping gurus aside, for small investors this is critical because its your hard earned money and one is answerable to ones family and has to investor for future needs. Quality of management is not about the layman ethics – its about business ethics – which means how well the company is governed and if it is transparent.

    Even cigarette and liquor companies can be well governed. We are talking about corporate governance (corporate ethics) not personal ethics here. Even these companies are legitimate and run legally.

    Okay in any case companies which take investors for granted will lose sheen sooner or later – take the case of Satyam. Similarly there are various groups which are not seen in this market.

    I’m not sure why you are defending certain companies. I’m not forcing your to accept my views or other views, but there is nothing wrong in also looking at the other side. I agree with the views of Jagadees and Pavan. The stock discussed is also removed from Nifty for various reasons, so there are negatives that have to be accepted, although some positives my exist.
    My personal view: “ITC is far better and well governed and attractive than Reliance Capital”. Look at the dividend yield, quality of management, return on capital/equity, consistency of earnings/dividends, etc.

    • TIP Guy says:

      Hello Chinku,

      Thanks for leaving thoughtful comment. Regarding defending certain companies… No, I was not attempting to defend any company. I was attempting to answer questions about “company not being ethically governed” and hence one should not invest. What I have attempted to describe is, at personal level, my foremost objective is to make money. If I think its purchase price has flexibility to make money over time, then I do not hesitate. At an individual investor level, ethical governance is too big to manage.

      I like ITC too. But at the same time, I like Ferrari too. But Ferrari is too expensive for me to buy. I would not pass an opportunity to buy Ferrari at price of regular car. I hope you get the message.

      Best Wishes,

  10. Dev says:

    Why is this blog not being updated?

  11. Worli says:

    I had bookmark this blog a years back, why it is not updated anymore?

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