Satisfactory corporate practices reflect in various ways, including stock prices.
We have seen the prices of stocks tumble in a few trading sessions when the recent scams on 2G, loan-for-bribes and other suspected accounting frauds came to light. These have underlined that investors should invest in companies with good corporate governance practices. Corporate governance goes beyond disclosures that a company makes.
Board composition: The board of a company with good corporate governance has more independent members and professionals with repute. This helps to bring diverse expertise and improvise in business decisions and strategic thinking. If you look at the board at Infosys, not only are more than half of independent professionals drawn from varied fields; the position of chairman and managing director is also held by two different persons, so that corporate power is not concentrated in one individual.
Share price volatility: The share prices of companies with good governance are less volatile as compared to the others. Check the beta measure for Infosys or HDFC and compare it to that of companies mentioned in the 2G scam to realise the difference.
Disclosures: Companies with good governance practices are transparent in disclosing material information to its stake holders. The disclosure a company usually makes is on changes in shareholding pattern, financial results, acquisitions and other material information. It is also important that there should not be any insider trading on account of this information. Explaining what is being done is important. For instance, in the much-reported buyout of Honda from Hero Honda by the Hero Group, the price of buyout and the royalty payment to be made to Honda in future is still a secret. This has agitated some minority shareholders.
Financial results: Companies with good governance give steady financial performance. They usually have a healthy net worth and a good cash flow position. It is important to know the auditors of the company, too. Investors should also go through the financial results and audit report with a fine comb to look for any qualifications or observations made by the auditors. Many a time, the notes to accounts provide insight into the accounting practices. The Satyam fraud is a recent case, where the income and cash figures were inflated for years.
| Scrip Name | Industry | Mkt Price 2010 (Rs) | Current P/E ratio | Current P/BV ratio | Mkt Price 2007 (Rs) | Annualised Return(%) |
| COMPANIES WITH GOOD MARKET PERCEPTION | ||||||
| Infosys | Software | 3,292 | 32.58 | 8.58 | 1,622 | 34 |
| BHEL | Heavy engineering | 2,305 | 26.22 | 7.10 | 1,213 | 30 |
| HDFC Bank | Banking | 2,200 | 34.57 | 4.74 | 1,678 | 10 |
| HDFC | Financial Services | 691 | 35.64 | 6.63 | 576 | 7 |
| COMPANIES WHERE THE MARKET PERCEPTION IS NOT POSITIVE | ||||||
| ITI | Telecom equipment | 38 | * | |||
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# Price to Book value ratio cannot be calculated as Book value is negative
Good investor service: Companies with good governance have shareholder wealth creation as a prime objective and provide good investor services. They survey, take feedback and suggestions. Beside providing easy access on information to shareholders. Infosys puts on its website the information shared with analysts.
Companies with poor corporate governance practices have similar features in this regard. Such as:
Board problems: The board is filled with kin of the management and is not independent from its promoters or owners. At times, squabbles between the directors.
Transparency: Many a time, the corporate information published is either incomplete or not up to the mark. Some companies also hide material information.
Poor financial results: Such companies may have not only unsatisfactory results, but also abrupt fluctuation in profitability. There may be stringent observations or qualifications to the accounts by auditors of such companies for instance the audit report of the Comptroller and Auditor General of India (CAG) report on BSNL.
High debt: This is another feature of such companies, bringing them to the edge like, the market’s perception of Ispat Industries with regards to loan repayment issues.
Investor returns: Infosys has given a return of 34 per cent versus one per cent of the market index, the. S&P CNX Nifty. BHEL and HDFC Bank have given 30 and 10 per cent, respectively. However, Ispat and MTNL, mentioned in Table 2, have eroded shareholder wealth by 24 and 20 per cent in the three-year span.
Market valuation: Again, the companies mentioned in Table 1 have a better ratio in terms of price-to-earnings (PE) and price-to-book value (P/BV). In spite of their rich valuation, they have consistently rewarded their shareholders. Whereas, those in Table 2 have eroded investors’ wealth. The above data clearly show the companies with better market perception have outperformed the market returns handsomely. They are able to get better valuation in terms of P/E ratio and P/BV ratio. Due to their financial strength, they are able to raise capital and service it at ease. The objective of any company is to generate shareholder wealth. Having transparent procedures and proper disclosure, is the need of the hour. Good governance gives good valuation and better business prospects. A good guide for investing your money.
The author is a freelance writer