Thursday, June 28, 2012

Investment in stocks- An old fashioned way

2009- Thoughts on investment. Still green A few friends have called up and discussed the matter of building a portfolio for the long term after publication of my article about my friend at Mangalore (Adding Zeroes, Money Life, Oct_ 2009). The first and most important requirement is that the money you keep aside for investing in stocks should be money you can totally afford to ignore for at least ten if not twenty years. Ideally, this is the money that you plan to leave aside for your children in the form of stocks (barring unforeseen circumstances). Treat this for your personal calculations as money spent. And, also, do not invest if you are the type who will look at prices everyday and worry about the portfolio. Clearly you should not be in the stock market at all, your greed notwithstanding. Let me begin by listing out my biases towards stock picking. Since I am more of a pessimist than optimist, l will start with the characteristics I hate. In other words, I rule out companies with these characteristics: 1. Absence of dividend. A genuinely profitable company should pay out dividends. If the company does not pay dividends in spite of showing profits year after year, I avoid it; 2. Non-tax paying or low tax paying. A company that pays no tax or very low tax year after year is ruled out. If the profit is real, the company ought to be paying taxes; 3. Companies with very high debt worry me. In a good year, the business will earn a rate of return higher than the interest cost, but could be in trouble in a bad year. If the company passes muster on all other criterion, then maybe I will probe further, but in general, high leverage is a red flag; 4. Third generation family owned and managed companies. Indian companies are generally family owned and are passed down from father to son, like heirlooms, corporate governance be damned. Typically, in the third generation, the number of claimants increase and lead to a combination of poor management, siphoning and lack of focus; 5. Companies that show profits year after year, but do not pay dividends and yet keep raising equity regularly; 6. Change of auditors is a red flag. Investigate thoroughly. If not satisfied with the reasons, avoid the company; 7. Companies that keep advertising even if they are not in the consumer space; 8. Companies that are managed by so called professionals, but treat it like a fiefdom, engage in random diversifications that do not make any sense and award huge stock options; 9. Companies where the promoter has several other unlisted companies which siphon profits. (I believe most Indian companies do this, so the level of check required to ascertain this may not be possible for everyone); 10. Suspect management integrity. This is the most subjective one and in most cases, it would be turn out to be a question of degree rather than one of principle. I have hardly come across any company which will pass total muster on this score, so have decided to be a bit practical and take my chances; 11. Super normal profitability is another worrying sign. In most cases, this happens at a nascent stage, just around the time a company goes public and is planning further fund raising. If the whole industry is making 10% of sales as profit and someone is making 25%, my first instinct is to be sceptical. This is certainly a ‘red’ flag; 12. A ‘me-too’ company is one to be avoided. The company I choose should be clearly number one or two in its business. Only when you pick up companies that are in new segments (so called ‘sunrise’ industries like bio technology etc) can you look at small players. There is no point in looking at a small player in the textile business or in the FMCG business; 13. Companies in industries that are overly regulated by government. This is a debatable point, but I believe that given the circumstances, it will not be possible to dismantle controls on industries such as fertilizer, oil etc., Whilst ultimately it should happen, I prefer to keep away. In general, government interference (like in PSU banks) generally makes an investment less attractive whereas the event of government getting out completely from any company would make it more attractive. 14. In today’s funny accounting world, I am also wary of this thing called “consolidated’ accounts, when it includes profit shares of entities that are not 100% owned by the company. And, the companies do not even show the accounts of the subsidiaries on their websites! After this, I use some financial screens of which I hold the ROE (Return on Equity) to be perhaps the most important criterion. I would like it be steady to improving. Generally, my attempt is to focus more on cash flows rather than mere earnings. For instance, in any industry, you can NOT provide for bad debts and show earnings. However, the cash flow picture would be terrible. I give high importance to management in terms of competence and integrity. I also like to see companies that have the potential to grow at more than the pace at which economy grows. For instance, if we expect industry to grow at 10% and inflation to be 5%, then the company has to grow at more than 15%. Financial analysis is simple, but needs time and effort. I usually like to sit with at least three years annual reports. Unfortunately, today I see the annual reports getting more opaque. Financial information shared with the investors is getting less and less. I get a lot of useless diatribe from the management under the head “management discussion”. Here, no company is going to openly admit its faults. You will get to read only good things or blame on external factors for poor performance. Real issues are buried. From the above, it is clear that for investing directly, you need to spend time. Once you decide to invest, have a specific sum set aside and stick to the discipline. NEVER borrow to invest. And review your investments at least once a year. After making an investment, if you realise you have made a mistake, get rid of it immediately, without bothering about the price. I have seen people not selling their mistakes because of an inability to take losses and then see it becoming worthless over time. Do not sell unless you really need the money or have a better use for the money in terms of returns. One more weakness I have is with regard to timing. If I like a company and it is doing well, I will not sell. The price does not bother me. And another thing I have found out. If you hold an investment for more than a decade or so, then the dividend income generally is quite substantial as compared to your original cost. I believe that over time, dividend income should become quite substantial, if you are a patient investor. What I have given above is from my experience. More importantly, my attitude to investment is totally different from most. For me, investment is with money I have to spare. I do not trade. So, you see, I am the complete ‘gambler’. Investment in shares is no different, to me. When I invest in shares, I am taking a chance on the business competence, outlook and the promoter. Sometimes I win. R. Balakrishnan ( November 2nd 2009.

Sunday, June 24, 2012


INDIA’S CREDIT RATING (This article appears in today's Deccan Chronicle/Asian Age) (you can see it at There is a debate on about credit rating agencies and their actions or pronouncements on India. Naturally, we get emotional about it and think that as a nation we will never default. History is witness that we have defaulted at least twice post Independence. And many people take irrelevant numbers and compare India with other nations and feel strongly that we are better than so and so country that has a higher rating etc., To put it in perspective, Indian economy has always been short of being an investment grade on a standalone basis. Yes, we can get a higher credit rating, if we stop importing oil. We must stop importing oil and everything else must be the same. Our exports, our software earnings, our NRI remittances etc., Frankly, I think this is not possible. If we stop importing oil, one can imagine the ripple effect. The auto industry would be a fraction of what it is today. We can only have an auto industry that can be supported by the domestic oil produce. Maybe if all Indians pledge to stop buying gold, it could improve the country’s credit rating. It has to be voluntary and not a forced one. Every import (other than perhaps the nefarious thing called precious gems and jewellery or gold) has a contribution to our growth. So, if we do stop importing something, there would be a ripple effect somewhere. If we can control our appetite, surely we can get a better credit rating. However, controlling one’s appetite is blasphemous! How dare I suggest that Indians stop buying gold? How can I tell them to stop driving cars? It is simply not done. So, structurally, we have a receipt and payment account, where our payments in foreign currency exceed our receipts in foreign currency (our trade deficit) by nearly a billion dollars every day! For a full year, we have a dollar shortfall of 300 billion! We are a fortunate nation. Indians, who have left for better pastures overseas, send in close to five billion dollars every year. So, we take care of some of our hunger for dollars through the dollars they send us. For the balance, we have a serious problem. We can either borrow or make the foreigners send in money in dollars to invest either in industry or our stock markets. Unfortunately, we do not permit them to invest freely everywhere. For example we do not let them invest in agriculture. The fear is that if they bring in better techniques, the local farmer (who is subsidised every which way) will cease to exist. We do not let them buy land for fear that they will drive up the prices. We do not let them set up retail shops for fear that the local baniya (who serves you adulterated dal and food grains) will go out of business. We need at least another two hundred fifty to three hundred billion dollars every year, to keep our economy growing. Ideally, we should not borrow. For, if we borrow, we will be unable to repay since we are perennially short of dollars. The only solution is that the politicians wake up and create an environment where the foreign money is having a sense of safety. They are used to taking risks. All they need is some comfort that the local laws do not surprise them (like Pranab Mukherjee trying to collect some dues on a transaction of many years ago or changing the laws every year). Or take our archaic labour laws. The fear of having to carry labour without having the ability to get rid of them is a big handicap. The leftist approach of ‘job security’ has resulted in jobs not getting created at all. The entire manufacturing base of the world has gone to China. We have missed out big time, thanks to the vested interests of our political leaders. To me, this is treason of the highest order, where they deny a better life to its citizens on the pretext of protecting them. India’s credit rating has always hovered between the highest in the junk grade (Double B) and the lowest in the investment grade (triple B). So there is not much to cry about, except that when one moves from investment to junk grade, a lot of money shies away from us. Many investors have charters that prohibit investment in to junk rated investments. They will be compelled to pull out any investments in India and new ones will be put off. It is not just an impact on cost of borrowing or investment, but an impact on how much money India can attract. The tragedy is that we have seen the benefits of opening up the economy in 1991 and now in the last two years, we have kind of pulled down the shutters. This clearly proves that the current PM has learnt nothing in spite of having been around in 1991. What this entire drama means for us is that a downgrade can have a bad impact on stock markets and on the exchange rate of the rupee. In turn, it will contract our economy besides adding to inflation. It is futile and illogical to argue that rating agencies are wrong. They do make mistakes. In this case, the only mistake they are perhaps erring is on the side of caution, I think. It is past being a wake-up call. Our economy can either recover to a 7 to 8 percent growth level or go back to the five and six percent rates. It all depends on whether the government has the courage to let go. In the meanwhile, it is best to keep one’s money in fixed deposits or in Fixed Maturity Plans or in Bonds of companies.

Wednesday, June 20, 2012

State of the markets- Expensive even today

Moneylife » investing » stocks » stock-investing-are-stocks-really-cheap Stock Investing: Are stocks really cheap? June 19, 2012 12:09 PM | R Balakrishnan There is a widespread propaganda that stocks have become undervalued. Think again All professional money managers are parroting that stocks are undervalued currently. A pile of statistical data is produced everyday by a multitude of analysts working in broking companies that emphasises the undervaluation—using earnings forecast of not FY12-13 but FY13-14. This is called ‘forward’ earnings and is used to make a comparison with the past. They are all making the claim that the markets are at their cheapest in terms of many measures, including P/E ratios. I look at stocks prices, market indices and forecasts of companies, and find myself at odds with the masters of the markets. Good quality companies (where I can breathe easy and become a Rip Van Winkle) are at multiples of over 20-25. Nothing, except government-owned banks, is being valued at single-digit multiples of its earnings. Well, if I believe that the stock markets are a reflection of the expectations of investors, then surely what remains expensive will continue to remain so, unless the expectations take a turn. If anything, they can take a turn for the worse. A lot of optimism is built into the forecasts of brokerage companies. After all, they have an interest in sounding optimistic. Let’s look at the problems facing some of the key sectors. If you take the banking industry, we have the universe of government banks, none of which inspires trust. They change their basis of accounting and classification of loans like we change T-shirts in the Chennai summer. So, comparison of results from year to year is a thoroughly useless exercise. If I go by the news of industrial slowdown, the expanding basket of sticky loans to large borrowers in aviation, microfinance, textiles, real estate and infrastructure, how can I believe that a government bank has actually reduced its problems? More so, since it is these banks that had the size and malleability to have funded large (and dubious) borrowers (such as State Bank of India’s generous funding of the sinking Kingfisher Airlines). So, if we see stocks of a government bank trading at 3-4 times ‘reported’ earnings, there could still be a lot of downside. Sure, there is an upside possible too: when we see hordes of foreign investors coming back to buy Indian stocks as if they are limited edition copies of rare manuscripts. Then we have oil company stocks which are neither expensive nor cheap. The excellent results of Bharat Petroleum and its bonus issue seem to be totally at odds with what is happening in the sector and disconnected from the politics that surround the industry. Does any one of us, even for a moment, believe that the chairmen and managing directors of oil companies actually decide the fuel prices? Is it not obvious that they are making these statements on the orders of their political bosses? How do you invest in such companies and not worry? Auto stocks are no bargain either. If you go sector by sector, probably some metal stocks look undervalued by traditional yardsticks. But metal stocks, like Tata Steel or Hindalco, have become more global than Indian. Worries in Europe and America are ruining their bottom lines and they have become truly ‘cyclical’ stocks; so one cannot pay too much for these anyway and most long-term investors will keep away from them. Tata Motors is also headed this way; its fortunes are tied to global economy and markets. Our pharmaceutical company stocks are another ‘safe’ sector with reasonable growth prospects. However, none of them appears to be at bargain valuations. That leaves us with the ‘technology’ sector that supplies labour to the world. The rupee’s weakness is surely a good thing for them. At the same time, their labour costs are going up; there is restlessness in the industry and there are doubts about their ability to go to the next level of growth and efficiency. Considering all the worries, the stocks are not at the bottom-end of their valuation band. Inflation continues to be the friend of sectors that are engaged in direct consumer spending. With supply not improving (since there is a lack of confidence among businessmen to invest more money to expand), consumer demand is still driving prices higher. Consumer companies keep finding cleverer ways to increase prices at a rate higher than inflation and are enjoying a golden period. I have not even gone into a discussion on sectors like ‘infrastructure’ or ‘telecom’. These sectors have a great need to keep raising fresh rounds of equity and will remain out of my radar until they become mature companies. We are all fretting because the indices seem to be kind of hanging in there, unable to break out of a range. Well, I wonder why we complain when we have got a 20% return in the first two months of the calendar year. The real worry is the attitude of foreign investors to our markets. They are the pillars and the foundation of our markets today. So, we have to keep praying that their money will keep pouring in, to provide exit to temporary hands that hold them and the new supply that Indian promoters keep providing them with. Indian investors clearly overreached in the 2005-08 boom with most people who could not afford equity risks, putting money into mutual funds and direct equities. So, we have to wait for retail investors to come back. Maybe the downside of this market is limited to around 10%-20% from these levels. However, there is no guarantee about the trigger that would attract money from foreign investors again. Until then, we can only hope that our politicians do not give us such a scare that our GDP growth rate expectations fall back to the Hindu rate of growth. As a strategy, if I do make a bet now, I would buy exchange traded fund of the Sensex for a one-year horizon, with a planned exit when the return nears or exceeds 20%.

Sunday, June 10, 2012

Think Equities, Think Long Term

(This appeared in the Deccan Chronicle of 10th June 2012) THINK EQUITIES- THINK LONG TERM The turn of the millennium changed the mindset of investors. We had an old set of investors who were happy with their winning the lotteries in the form of share allotments in regulated low priced public issues. Then there came the new breed. Stocks doubling in anything from one week to six months became fashionable to gun for. Stories of success always spreads like wildfire and no one wants to talk about failures and losses. Public lore made our stock markets as a ‘sure’ route to untold wealth. Alas, the first round was too brief and savage. 2001 came like a butcher, killing all including the bystanders. Many people swore off equities as the borrowed money invested in the stock markets became a huge burden. A healing process and by 2007, things were back in full swing. Everyone had reliable information on so many stocks. Mutual funds raked in money through the IPOs. Yes, long term was okay, so long as it was not too much more than a year. Then 2009 came and destroyed everything. New entrants were trampled upon. Most exited in panic. Those who stayed through the massacre of 2009 and put in new moneys reaped big rewards. Alas, the picnic ended too soon. The fall was brutal and the rise caught most unawares. Those waiting to time the markets could not get in as the election results of 2009 shut out new money from the gains. Now, introspection and fear dominate the investors. We see that even if one had stayed for five years in a SIP in the broad market, the returns are like savings bank deposits, at best. Then if one looks at a ten year record, things begin to make sense. In the last two years, our markets have witnessed a divergence that is not usual. Stocks of companies in sectors like FMCG and Pharma have witnessed huge run ups. It looks like there is a flight to quality. This makes me confident that we are not in a bear market. Investors seem to prefer less risk in their stock picks. Stocks of the momentum era (real estate, infrastructure, metals etc) have fallen badly, some by as much as ninety percent. I suspect the market capitalisation is half of what it was at its peak. Money is still around in plenty. That itself keeps the bear away. In spite of the innumerable troubles surrounding the globe, every stock market is doing okay. No bargains in value terms in any markets as a rule. None of the markets are in single digit P/E multiples. The most worrying thing seems to be the lack of faith that we have in our companies. Corporate results have been fairly ok in this gloomy year of low economic growth. Yet, the Indian retail investor is leaving equities to seek peace in fixed deposits, bonds, bank deposits and gold. Our equity markets are totally dependent on the FII money flows. If they pump in money, the markets go up. If they don’t do anything, our markets remain flat. If they sell, the bottom falls out. There is no counterbalance to the foreign investor. The FIIs are a mix of long term and short term players. Most of the FIIs stay invested for long in markets like ours, where the growth rates are the attractions. Government actions, inactions and scandals do dent their confidence, but they seem to be far braver than us. They realise that Indian corporate sector is doing well and will do so, in spite of government. Investors clearly are worried about government owned companies, which do not seem to have the profit motive that drives stock prices. The money which chases these stocks put their faith in the government of India seeing sense in letting go of the management at some time. Maybe the expectations do get tempered from time to time, but everyone knows that given the poor financial health of the sovereign, it is a matter of time before corporations are driven by free market forces. Failure to do so is like pushing a self destruct button. The goings on in the market makes it clear that equities are for the long term. Equity investment has to come from money that you do not worry about. You cannot put money in equities today, hoping to use it for a specific need in the next few years. It should be used more for estate or wealth creation. The individual has to start with fixed income for most defined needs and then use equities out of the balance money. Timing of entry can be decided, but there is no control over markets when we want our money. Yes, we may get a panic situation like in 2009 or so when the index cracked to below 10,000. Today, if it cracks to around 12,000 it may be a great time. For these kind of opportunities, it is important to preserve liquidity. Equities are for investment and not savings. If we can understand the distinction, we will not cry about markets. Fixed income can only give us so much money. Keep investing in equities if you want to create wealth.

Saturday, June 9, 2012

Are governments necessary?

(From The Daily Reckoning 0 Freedom, Naturally By Joel Bowman It is at times useful to imagine how a truly laissez-faire society, one entirely emancipated from the shackles of state coercion, might exist and operate. Morris and Linda Tannehill examine this very idea in The Market for Liberty: Is Government Really Necessary? The Market for Liberty imagines a totally free society — one with no government intrusion whatsoever — in which the free market is left to respond to the demands of individuals without recourse to institutionalized coercion, implied or actual. Is such a stateless existence even possible, much less preferable? Or, as so many contend, is it merely an academically contrived utopia? Morris and Linda Tannehill address all the usual fears and protestations that a truly nongovernmental — i.e. anarchist — society conjures up. Whenever there arises in conversation the mere suggestion of a totally free, laissez-faire market — the possibility that human beings might even be able to survive (much less thrive) without the safety net of state control — apologists for “benevolent government” invariably step atop their soapboxes and ask, “Yes, but who will provide education for the masses, if not the public schools?” or “Who will care for the sick and weak, if not the public hospitals?” Indeed, these are questions that deserve thoughtful, honest answers. But these questions assume realities that are not in evidence. They suppose that “the public” (i.e., the state) actually has money to “provide” these services, rather than, as is actually the case, first having to expropriate (steal) it from private, productive individuals. Furthermore, the fallacy of benign governmental control relies on the idea that governments can provide essential services more reliably and cost-effectively than the private sector. In other words, the government’s obligation to provide essential services is more reliable and effective than the private sector’s opportunity to provide essential services. Admittedly, this debate does not lend itself to easy, black-and-white conclusions. But as the Tannehills argue persuasively, the free market provides solutions that governments would never dream of. “The big advantage of any action of the free market,” contend the Tannehills, is that errors and injustices are self-correcting. Because competition creates a need for excellence on the part of each business, a free- market institution must correct its errors in order to survive. Government, on the other hand, survives not by excellence, but by coercion; so an error or flaw in a governmental institution can (and usually will) perpetuate itself almost indefinitely, with its errors being “corrected” by further errors. Private enterprise must, therefore, always be superior to government in any field. (It is worth mentioning here that corporations acting in collusion with the state are not private enterprises as the Tannehills define them. They are simply entities that have co-opted the government’s “gun-for-hire” to do their dirty work for them. Think Wall Street “bailout” recipients and their army of DC lobbyists. Indeed, think any institution at all that seeks unfair protection or promotion from the state.) The lines on the battlefield between the comfort of state control and the liberty of anarchy are familiar to all. The state is a protector, one side argues. The state is a prison guard, the other side argues. • How, the statist is heard to question, might common disputes find resolution without the currently preferred monopoly of the state’s courts? • What about private monopolies that would ruthlessly jack up prices and bleed us working-class proletarians to death? • By what means might a laissez-faire society offer protection from foreign aggressors? • How might the personal liberties underpinning the whole system be protected if it were not for the tireless work of the state’s police and its myriad other law-enforcement agencies? Indeed, the statist continues, how would “the law” itself even come into being, and in what shape would it find application in the absence of the all-knowing, all-powerful state? The Tannehills address these anxieties thoroughly and logically. “Freedom is not only as moral as governmental slavery is immoral,” they write, “it is as practical as government is impractical.” Discussions criticizing the state’s myriad shortcomings and follies are many. The Tannehills’ Market for Liberty takes the extra step in providing viable, concrete solutions to state-sponsored dilemmas. The free market, they argue, can correct the state’s tendency toward costly excesses, and can do so peacefully and voluntarily, simply by following price signals from the market itself. The Market for Liberty is, for all intents and purposes, a very real, practical solution set to those most commonly presented excuses for acquiescing to governmental authority. The government is not merely a “necessary evil,” the Tannehills argue. “It is necessarily evil.” Of course, The Market for Liberty does not project a utopia in which acts of violence simply disappear and where every individual immediately sets off on a long road to perfection. Rather, the authors illustrate how individuals acting in their own self- interest, coming together to engage in mutually beneficial exchanges, are thus incentivized to act with honesty and integrity. “The history of governments always has been, and always will be, written in blood, fire and tears,” the Tannehills assert. In The Market for Liberty, they show how freedom is not only an alternative to the state, but a far superior one worth, at the very least, our immediate and undivided attention.

Monday, June 4, 2012

Of Credit Rating

(This article appears in the latest issue of Moneylife. I also confess that I have worked for CRISIL and admire the organisation even today. I learnt so much there) FAITH ACCOMPLI Credit Rating has become a controversial topic. No one seems to like credit ratings. This dislike comes from investors who attribute credit ratings as the cause for the Lehman crisis, sovereigns that have had their egos bruised by rating downgrades and companies that generally get ratings lower than their own expectations. In a world without credit ratings, the investment universe would perhaps shrink dramatically. Investors would be forced to do their own analyses of companies across the globe ( or at least in terms of where they can invest) or fall back on ‘name’ recognition. Sitting in Mumbai, a fund manager may not know enough of an issuer in Coimbatore or in Ludhiana. He has to perforce undertake the full analyses himself. Of course he can always fall back on a ‘sell side’ broker report. And this broker would be someone who is also earning some fee from the issuer. And no issuer is obliged to share the future with a broking firm or with a journalist. In case he does so, it would be voluntary and only project what he wants to be seen as. There is no one to pay the Devil’s Advocate. And of course, in the absence of credit ratings, interest rates would be driven by perceptions. An issue from a known stable or group would get snapped up easily and an unknown issuer with better credit would end up paying up higher costs. Without ratings, the investment universe would be a smaller and inefficient place. I believe that credit ratings serve a very useful purpose. To my knowledge, the fact that the issuer pays a fee to get his issue rated has not so far been a reason for any bias. Fees are uniform across the issuer universe. Yes, it is possible that some late entrants or those with lesser market acceptance may use fees as a tool to attract some business. Or they may promise some issuer a higher rating. This cannot last for long. It would be short lived and ultimately, the market place knows how to differentiate. Whilst we have five ‘recognised’ credit rating agencies, the investors do make a distinction in pricing, depending on which rating agency has assigned the rating. The rating agencies that compromise on ethics and standards survive only because there are pools of money belonging to governments and provident funds, which go by the rule book. They don’t care which agency. As long as a ‘recognised’ agency gives its ‘chop’, they are okay. This lets the not so creditable agencies get business. I will not name them but every player in the market knows the names. I was shocked to hear about a company going to court and blocking the likely ‘downgrade’ of its credit rating. And the court, surprisingly, issued a stay! This means that the company was virtually sure of its downgrade! And the names were in the press, so would investors not react? More shocking was the stay granted by the court. After all, credit ratings are opinions. They are not a recommendation of any sort. Tomorrow, can a movie producer get a stay on a review by a critic? I am a solid supporter of plain vanilla credit ratings on bonds. However, when it comes to fancy stuff like securitisation or the IPO grading, I hold a different point of view. Securitisation is a complex exercise and the basic flaw is in assigning highest ratings on par with vanilla bond ratings. Securitisation ratings are mere statistical exercises based on past behaviour, whilst credit rating is a forward looking opinion. The past statistics are based on a set of circumstances which keep changing from day to day. To this extent, there will be huge errors of judgement. So far, globally, securitisation has been a mere eye wash and there has never been a true sale. What happens here is that an originator (say a bank or a finance company) sells a bundle of loans (could be home loans or vehicle loans etc) to a Special Purpose Vehicle (SPV) which is typically a Trust. This Trust issues papers representing undivided shares in the pool of loans to investors. However, in reality, this Trust is a paper entity and all the action continues to be done by the lender. Securitisation is a mere window dressing exercise designed to help lenders to borrow beyond prudent limits. Similarly, IPO grading has been an addition that has not worked out too well. The problem with IPO grading is the lack of co-relationship between a grading and the issue price. Most users of IPO grading will assume that a high grading would mean a great issue in terms of returns on the offer price. The truth is that higher the perceived quality or strength of an issuer, the higher is the pricing likely to be. And IPO pricing today has generally been on the excess. So, an IPO grading at best can talk about the likelihood of the company being around for some time. Here also, the pitch is queered by the quality of credit rating agencies around in India, not all of whom do a honest job. My fear is that the IPO grading would not even help us to detect ‘vanishing’ companies. Also, unlike credit rating on bond issues, the IPO grading is a onetime exercise and rating agencies can easily be taken for a ride by a smart promoter. The other vexed issue is one of ‘general’ ratings. Here, I do not find much in to it. It just becomes like equity research with no real use for this rating. The other worrying thing to me is that the nationalised banks (which are generally slack in credit appraisals) are passing the buck by forcing companies and SMEs to go in for credit ratings. It is difficult for me to digest the credit rating yardsticks being applied to SMEs that are one man shows and are in unorganised sectors when they kick off. The only persons to benefit would be ‘consultants’ who promise to assist these SMEs to get the process completed. However, the rating agencies have marketed themselves very cleverly and ‘rate’ everything from hospitals to buildings. Perhaps there is a scope for extending their expertise to restaurants and compete with the Michelin Guide. I only hope that it provides some value to the consumer. If one has to use credit ratings, do not look beyond plain vanilla debt ratings on either bonds or fixed deposits. Commercial Paper or short term ratings are no indicator of company strength since it focuses on the short term. A company with a high Single A rating could have the highest short term rating. Remember that credit rating is an opinion and merely helps you with an additional input. It does not absolve you of your homework. And also remember that there are differences between ‘recognised’ credit rating agencies. And the truth is that globally, credit rating agencies are very powerful and the plural term is used because there are two of them who dominate the business. These global agencies used to assign ratings only on the global scale. In essence, it meant that if India has a rating of “BBB-“, no Indian company could get a higher rating. It was CRISIL that broke this system and assigned ratings on a domestic scale. This practice was pioneered by CRISIL and other agencies in the region followed. Ultimately, the American agencies had to accept this scale. Alas, they are snapping up regional agencies and to that extent, the duopoly is getting stronger. Maybe, China will take the lead and we can have a rating agency that competes with the American ones.