Contrarian investing is a much discussed subject. We all know that buying when there is blood on the street is the way to wealth. But, blindly buying when there is blood on the street could also leave you holding onto a dying animal. The risk on corporate governance is very material to the success of contrarian investing. When greedy promoters leverage their company, their promoter capital and everything they have to build their market capitalization, the risk they create increases geometrically. It is like a cascade of risk. When the promoter reaches a dead end, the show collapses. We call it the `Hyderabad blues’ after seeing several Hyderabad based companies follow this pattern of operating. The show stopper was of course Satyam. This brings us to the question of what goes wrong in these companies? One, leverage kills when it doesn’t create returns to support it. Two, excess leverage inevitably turns your business operations into a hedge fund. Three, leverage on the company, the promoter and the market capitalization will inevitably lead to the collapse of all three. The success of one company in India in protecting all three over the past three decades by following this model is possibly a product of the times they operated. Those times are over. Which is why we find many companies following the same model of governance simply sinking without a trace. Investors are left fuming, angry and despondent when they become victims of such companies. But, what you need to learn is to avoid such companies at any price. At times, the blood on the street maybe that of a dying animal that can’t be revived. Some birds simply cannot take flight again.
Beating the investment cycle happens only after you take a small beating. You go down only to emerge on top of the cycle.