“So you are sure you will be able to meet your sales growth target for this year?” I asked as the CEO of the company looked at me.
“Yeah, we are pretty sure that we’ll be able to grow our sales by 30% this year and the next one, and 25% every year thereon.”
“And what are the risks you face?”
“Risks? Hmmm.” He looked out of the window for a minute, then turned back to me, and said, “I don’t foresee any risk for our company, at least not over the next one year.”
“That’s great!”
This was how my meetings with the CEOs or CFOs of companies went through when I had just started in my career as a stock market analyst.
Whatever the CEOs and CFOs told me were like words cast in stone.
So if they were confident of a 30% growth in their company’s sales for the next 10 years, even I was confident that they’d we able to achieve that…and without any risks!
And if they were confident they won’t be making any poor investment decisions in the future, even I was confident that they’ll stick to whatever they were saying.
Well, it took me almost 4 years and a few bad recommendations to realize that whatever company managements say must NOT be taken at face value.
It’s psychologically dangerous, because analysts and investors who talk to management get confident for all the wrong reasons.
This is not because CEOs and CFOs are liars. This is because we are all liars…and especially to ourselves.
We generally look at our plans and decisions wearing rose-tinted glasses.
So, if you question the CEO, “Are you going to do a stupid acquisition?” there’s a great chance he’ll tell you what you want to hear (“No!”) until one minute before he announces he has done the exact opposite thing (i.e., actually did a stupid acquisition).
But then, people never change. That sounds harsh. But it’s an effective way to invest.
A management that has a history of borrowing money to grow its business will keep borrowing. A CEO who is a serial acquirer will keep acquiring companies left, right, and centre. Someone who has a history of going overboard with future plans will continue to go overboard with future plans.
Now, whenever I am studying a company’s managers, I start with the mindset of seeing them ‘guilty until proven innocent’.
So if they have a history of making bad decisions, I don’t believe them when they say they’ll stop making such decisions in the future.
I treat it just like if an alcoholic said, “Tomorrow I’m going to stop drinking.”
Okay. I appreciate the sentiment. But we both know what’s going to happen tomorrow!
The Lesson Learnt
Business channels have this habit of calling top managers on their shows just after their companies have announced quarterly results.
More often than not, even when a company is staring at a deep slowdown in sales and profits in the future, the manager will be at his buoyant best.
“This slowdown is just a short term thing. We are confident of a strong growth in the future,” he would assure viewers.
Now whether viewers get assured or not is a different story. The anchor definitely is impressed and his follow up questions to this manager are just to support the latter’s claim that ‘the future is bright’.
I used to think the kind of questions that were asked to the managements on these channels were quite impressive.
That is till the time I also laid immense confidence on whatever the managements promised me during our research meetings.
But, after I learnt the lesson of not taking the management’s words on face value, and instead doing an independent and unbiased analysis on companies, those questions seemed hilarious.
Anyways, that’s not the real point here.
The real point is that until you as an investor get demonstrated proof of the management’s change in behaviour (from bad to good) – not just language but a real change – just smile and nod and not believe a word they say.
Some would advise that you can avoid studying a company’s management before buying a stock because there are no numbers to measure a management’s performance.
But that is a very bad idea.
You must assess or talk to a company’s management to understand its past behaviour – capital allocation record, business ethics, and shareholder friendliness…and to assess whether they are the right people to guide the business in the future.
But asking managers how fast the company will grow in the future and how confident they are on its plans? That’s not worth your time and effort.
I admit it. It’s taken me years to get this simple lesson through my thick skull.
I hope you can learn this lesson quicker than I did.
Hi Vishal,
What a timely article. I was just going to write to you about this…
I want to know the future of company ‘Tech Mahindra’ .. All people know that they acquired Satyam and hence started bagging projects about finance verticals.
Recently they also announced bonus and stock split. All my friends are going ga-ga over this and many of them are even giving me See-I-told-you kind of look but I am not so impressed.
Let me explain 3 reasons for my bearishness …
1) The number one concern is the acquistion/merger strategy of management. Over past few years the only thing that management is looking to do is acquire, acquire and acquire. See the list below
2007 – Acquired iPolicy Networks Private Limited
2009 – Tech M wins bid for fraud-hit Satyam Computer Services
2012 – Tech Mahindra acquires Hutchison Global Services for $87.1 million
2012 – Tech Mahindra buys 51% stake in Comviva
2012 – Tech Mahindra acquires vCustomer BPO for $27 million
2013 – Tech Mahindra acquires Sweden-based Type Approval Lab
2014 – Tech Mahindra acquires Lightbridge Communications Corporation, Global Network Leader
2015 – Tech Mahindra acquires SOFGEN Holdings, a 450-employee Swiss IT firm serving the financial services industry
2) Last year we didnt received appraisal saying that appraisal cycle is going to be shifted, so that it will now became Jan-Dec appraisal cycle (instead of previous Apr to Mar cycle). Considering that, the appraisal that we received now (after 18 months) was at the best average.
3) Since last couple of years company is no longer interested in keeping good, experienced employees. They just want to replace them with freshers and B.SC/BCA guys. Now even though i agree that restructuring cost cutting is important activity for increasing companies revenue, I think no fresher can ever replace talented experienced resource.
So I think company might go steeply downhill in future.
What do you think about this ? I am no valuation expert, so cant comment whether the companies acquired are bought at fair price or not ? Could you please guide me Vishal ?
Thanks Vishal for sharing your view.
If a CEO is certain about growth this year, I can understand that, because he is aware about what is happening in the company and he could co-relate that to current year financial performance.
But, if he is showing confidence in (30%) growth next, year, in my view it requires extra cautions. As you said, any management statement required cautions, but future year growth projection confidence would warrant even more cautions.
High projection will already be priced in the stock, so even if the company performs as per management projection, it would not result in price appreciation (information is already priced in the stock price) . But, if they miss the projection- the stock price will suffer.
High future certainty- which could be good thing- but as a human we have to tendency to overrate one’s foreknowledge (as Howard Mark says). This applies to CEO/CFO as well. If they see growth in profit/revenue with high certainty, they are likely to embark upon adventure keeping in mind rosy future. It means hugh investments, exciting acquisition, more capital raising- which may- and eventfully will be detrimental to long term shareholders when the tide turn(when the picture will not be as rosy as they thought it would be)– if we are not careful as investor.
Parag