“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1." - Warren E. Buffett

Saturday, March 14, 2009

Safety tips for Investors

Recently my friend sent me this article about safety in investing,since,there are some pretty interesting points mentioned in it,I wanted to share with you.

Clear capital Ltd., a subsidiary of the UK's Noble Group Ltd in a report on the "tricks that promoters play at the expense of shareholders", has come out with tips for shareholders on what to do to check out a promoter.

The report prepared after the Satyam-Maytas debacle, makes some starling revelations about companies in the BSE500. It highlights the most common tricks that Indian promoters, including some of the biggest names, employ to enrich themselves at the expense of the shareholders. They named these three tricks as "pump and dump", "blab and grab", and "expense manipulation". They translate into pushing up stock prices and then selling their holdings announcing new ventures to garner more funds, and sucking our Cash by inflating expenses under various heads.

So, what should investors do to save themselves?
The report says very clearly while there is no cut and dried method to establish and promoters probity, there are at least there relatively straightforward ways to do this: Primary data contacts, financial analysis, and charting.
Primary data contacts in the promoter's industry, like customers and competitors, are a good source of data regarding the promoter's probity. The more basic check on the promoter's intentions are insider transactions. In most of the case studies carried out by CCL promoter sales usually foreshadow problems for the company.

The second way, financial analysis, the report says there is merit in tracking seemingly insignificant cost items like other operating expenses, miscellaneous expenditure and distribution expenditure. The important part of this is these items are highly discretionary and should fall in tough economic conditions, on the contrary if they rise it means clearly that the promoter has something to answer for.

The report makes the following points:
At least 30 companies in the BSE500 are using aggressive revenue recognition techniques. This is evident from the deterioration in their Cash flows from operating activities in spite of a rise in Ebitda(earnings before interest, taxes, depreciation and amortisation), suggesting early booking of revenues.

Around 60 companies in the BSE 500 seem to have booked "sales" which might have arisen from investment income or other income.

At least 10companies in the BSE 500 seemed to have shifted expenses from the current period by significantly reducing depreciation rates.

At least 15 companies have disbursed the bulk of their loans and advances to companies in which directors have an interest.

At least 25 firms had profits shown in the full year results significantly lower than the sum of the quarterly results.

The third way, charting, is a little complicated. The investor needs to make a chart of share prices versus volumes overlaid with corporate announcements and insider sales.

It is usually a good "initial screen" to highlight whether the promoter has an affinity for the first tow tricks mentioned above.