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Saturday, January 10, 2009

Lessons from the Satyam scam

What started out as an aborted acquisition deal among family members has turned out to be the worst scam in the history of corporate India.

It is no wonder that Buffett said: 'You only find out who is swimming naked when the tide goes out.' Economic and stock market downturns have a habit of revealing the naked swimmers.

Yes, the plural is intended. Satyam is unlikely to be the only one. Many companies which have been declaring bumper profits quarter on quarter during the bull run have probably been 'cooking' their accounts as well.

I would be particularly sceptical about the infrastructure and realty companies - specially those with negative operational cash flows. As the bear phase meanders along, be prepared for more skeletons tumbling out of different cupboards.

Here are a few lessons that not only need to be learned, but internalised as well, so that we can benefit from similar occurences in future.

1. "There is never just one cockroach in the kitchen". This stock market adage has been proven once again by Satyam. Management trickery is never a one-off deal. Satyam had been involved in several questionable deals over the years. The latest scam is the culmination of past transgressions. Once corporate integrity is in doubt, avoid that particular stock.

(In this blog post I had mentioned that Jagran Prakashan was my favourite among the newspaper stocks. I removed it from my 'buy' list when I found out that they had recently appointed several sons/nephews of the promoter group to top positions on fat salaries.)

2. Just because a stock looks cheap (because it has fallen a lot from its recent high) doesn't mean it can't get any cheaper. Satyam has dropped from above 400 to 180 to 40 and now 20. Quite a few small investors got excited and bought the stock when it dropped to 100 and then 40. That's throwing good money after bad.

3. Markets usually 'discount' good news and bad news in advance but have little clue about what Nassim Nicholas Taleb calls 'black swan events'. These are unexpected events that seem to happen out of the blue. But more so during distressed times. 9/11 was one such event - soon after the dot.com bust.

A good way to take advantage of such situations is to strictly follow an asset allocation discipline (discussed in this blog post).

4. As a small investor, stick to industry leaders. If you are interested in FMCG, don't look beyond HUL, ITC. If you like metals, TISCO, Hindalco should suffice. In financials, choose HDFC, SBI. Alternatively, invest in index funds. There is no point in chasing the no. 4 (like Satyam) or the no.20 in the hope of making a killing.

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