Stock Markets and Trust

02Jun10

Rolta India has been quoting at really attractive valuations (when compared with the average valuations given to a company of its stature) for quite sometime. A P/E of 8 would have been unwarranted for a company growing at such a fast pace with high ROEs. (Though I felt it was correctly valued, I used conservative assumptions and also, I feel, as mentioned before, that I have been doing a conceptual mistake in my valuations which I would talk about in another post.)

The reason why Rolta has been punished with low valuations is the following notice:

http://www.watchoutinvestors.com/Press_Release/sebi/2004167_comp1175.asp

They had practiced faulty accounting practices between 1996-2002/3. It is a case of revenue mis statement.

They had built certain products in house and transferred it from one division to another sub division. Both the divisions are a part of the company. Lets say one division of the company manufactured a fixed asset (which is used in manufacturing) worth 100 Crores with a life of 10 years (and hence depreciation expense of 10 crores per year) and transferred the assets to another division. The other division does not sell the product but uses it for manufacturing something else.

What the company has been doing is including a capitalized cost of the equipment in Sales. Hence it has included the 10 crores of capitalized cost in sales and I believe in COGS also of 10 crores. This does not change the net profits of the company since you are adding the cost in sales and also cogs. However it will show an increase in sales of 10 crores which is not correct. They do mention about this in the notes to accounts though. But mere disclosure of a wrong practice cannot make it right. SEBI passed an order asking them not to indulge in such faulty accounting practices.

This is the reason why Rolta has not received the valuations due to it. At least that is what I see being posted in many online forums. It may not have played around with its financial statements after the order but still once trust is lost in the markets, it seems to be very very hard to regain it. It is almost 6 years since SEBI passed the order. The market still has not given it the valuation due to it (assuming all present nos are correct).

Some more articles during that period:

http://www.business-standard.com/india/news/sebi-directs-rolta-to-streamline-accounting/158036/

http://www.financialexpress.com/news/it-raids-on-four-rolta-india-offices/112360/

http://www.e-investing.in/showthread.php?t=2644

I do believe that the FIIs opinion is changing slowly and they have started to believe in the company. Morgan Stanley has bought a few shares of Rolta last week. But the hope for investors is not whether Rolta will be a successful player in the future, though that is also an issue but a lesser one, but whether the management convinces the public that its books are fully in order. That would be the key to close the valuation gap.

Sub note: The company lost 30% in share price in 2004 when the sensex gained 70% after this news broke out. However one should note that once all hell breaks lose in stock markets, all stocks will go up. Between 2005 beginning and 2007 end, the share prices went up 8 times. It is again languishing now and in forums everyone is referring to the old story of accounting malpractice. It seems to me that everyone is a cynic only when markets are not performing. When the markets are going up, no one seems to care about anything. I remember the famous quote from Citibank head, Chuck prince before the sub prime crisis. “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

It seems to have haunted him for a long time after that.

We would be wise to remember Warren Buffet’s quote on the same lines when talking about a commodity mania.

“What the wise man does at the beginning, the fool does at the end. At the start of the party, the punch is flowing and everything’s going well, but you know at midnight, it’s all going to turn into pumpkins and mice. People think they’ll be able to get out just before midnight, but everyone else thinks that too. The problem is that, in commodities there are no clocks on the wall,” Buffett warned.


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