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DLF Fraud: One Big Lesson for Investors

Warren Buffett wrote this in his 1989 letter to shareholders…

Stick to proven management with a lot of integrity, talent and passion. After some other mistakes, I learned to go into business only with people whom I like, trust, and admire.

Sadly, 25 years after Buffett first said this and after his countless repetitions of this thought, investors continue to deal with managements that lack integrity, and have talent and passion not in conducting their business affairs honestly but in looting other stakeholders.

The latest case is that of India’s leading (if size matters here) real estate company, DLF, which has sent its customers and investors into a tizzy. This is after the stock market regulator SEBI barred it from raising money from the capital market for three years.

So, home buyers who have invested in DLF projects are worried because they fear the projects that have already been delayed may be pushed back further or even get stalled due to lack of funds with the company.

As for investors (or let me say speculators, who were playing with fire), they have already lost a bucket-load of money in the company’s stock. The stock is down 55% in just the past four months, and 90% down from its post-IPO highs in January 2008.

Now, individual investors own just 4% of DLF currently, and thus I’m sure most people reading this may have not lost money in the stock. But then, what about other similar businesses like Unitech and Suzlon, where small investors own over 15% and 21% respectively?

What makes more small investors buy such businesses and not well-performing ones like TCS, where they own just 3%, or Asian Paints (13%), or Pidilite (9%)?

Of course, valuation is one issue given that this latter class has been trading at reasonably high valuations for quite some time now. But it’s sad to know that most of us often forget the importance of avoiding gruesome businesses and their managers, however ‘attractive’ they may be trading.

Now, I am not going to talk about the quality of business in this post, for I have already written about it several times in the past, like here.

What I want to talk today is about the importance that investors must lay on management quality, and what Warren Buffett has said on this subject for years and years in the past.

Of Greedy Managers and Losing Shareholders
One of the most pervasive themes that Warren Buffett has dealt with in his annual letters over the years has been the relationship between corporate managers and shareholders, i.e., between the stewards of capital and its owners.

In case you have some doubts, the managers are the stewards of capital and you, by virtue of your shareholding in a company, are the owner.

This is what Buffett wrote in his 2002 letter to shareholders, while discussing the subject of corporate governance…

Both the ability and fidelity of managers have long needed monitoring. Indeed, nearly 2,000 years ago, Jesus Christ addressed this subject, speaking (Luke 16:2) approvingly of “a certain rich man” who told his manager, “Give an account of thy stewardship; for thou mayest no longer be steward.”

Accountability and stewardship withered in the last decade, becoming qualities deemed of little importance by those caught up in the Great Bubble. As stock prices went up, the behavioral norms of managers went down. By the late ’90s, as a result, CEOs who traveled the high road did not encounter heavy traffic.

Most CEOs, it should be noted, are men and women you would be happy to have as trustees for your children’s assets or as next-door neighbors. Too many of these people, however, have in recent years behaved badly at the office, fudging numbers and drawing obscene pay for mediocre business achievements.

These otherwise decent people simply followed the career path of Mae West: “I was Snow White but I drifted.”

In the same letter, he added…

CEOs must embrace stewardship as a way of life and treat their owners as partners, not patsies. It’s time for CEOs to walk the walk.

Now, given the way countless CEOs and their teams have treated minority investors in the past, Buffett’s advice has surely lost its way in the corporate circles.

Like in DLF’s case, it took SEBI almost seven long years to understand that the management “misled and defrauded” investors while raising money in its IPO in 2007.

We can obviously ignore that some of the company’s advisors during the IPO included reputed brands like Kotak, DSP Merrill Lynch, Lehman Brothers, Citigroup, Deutsche Equities, ICICI Securities, and UBS Securities.

After all, it’s not the job of a banker or an investment banker to advice you on the risks to his advice. His work starts and ends with his fat incentives.

This also holds true of the CEOs and their cohorts of talented MBAs and CAs, whose information disclosures are aimed at getting the best credit ratings and the lowest interest rates for their companies, shareholders be damned!

Anyways, Buffett wrote this in 1994…

The people who make the decisions should be accountable for the consequences and face both the downside as well as the upside.

In our book, alignment means being a partner in both direction, not just on the upside. Many “alignment” plans flunk this basic test, being artful forms of “heads I win, tails you lose.”

Assessing Management Quality
In the original version of The Intelligent Investor, Ben Graham began his discussion of a chapter on “The Investor as Business Owner” by pointing out that, in theory…

…the stockholders as a class are king. Acting as a majority they can hire and fire managements and bend them completely to their will.

But he changed this part in the subsequent editions of the book. In practice, says Graham…

…the shareholders are a complete washout. As a class they show neither intelligence nor alertness. They vote in sheeplike fashion for whatever the management recommends and no matter how poor the management’s record of accomplishment may be.

The only way to inspire the average American shareholder to take any independently intelligent action would be by exploding a firecracker under him.

Well, this is a fact that is true for not just American shareholders, but all shareholders.

Most of us overlook the human aspect of operating a business. This is despite the fact that, in most cases, the future success of a business is directly tied to the quality of its people.

Instead of focusing on management, most investors would spend their time determining whether a business has a competitive advantage or moat, or if it is trading at a low valuation, because they believe that products or operational strengths are what set the most successful organizations apart.

The truth is that, over time, these advantages can be imitated, and if the talented managers who created these advantages leave the business, then the business will struggle to continue to innovate and create value.

Thus, I am not surprised when legends like Warren Buffett and Charlie Munger lay great emphasis on well managed enterprises and form an opinion of the management of any company before buying a stake in it.

Now you may wonder – “But how do I check for management quality, especially when it cannot be put into numbers?”

In his 2002 letter, Buffett suggested three management quality checks for investors…

First, beware of companies displaying weak accounting. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the kitchen.

Second, unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other managerial explanation, it’s usually because the CEO doesn’t want you to.

Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly (except, of course, in the offering books of investment bankers).

Charlie and I not only don’t know today what our businesses will earn next year – we don’t even know what they will earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future – and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to “make the numbers” will at some point be tempted to make up the numbers.

The case of DLF and several other such companies may not always be of making up numbers. In fact, the numbers here have clearly shown for years how these companies are meant to be destroyers of wealth.

Despite this, it’s tough to understand what makes investors lap up these stocks knowing well in advance that they can lose their capital permanently.

Please remember that in the stock market…

  • Whatever can be sold will be sold, and
  • What seems to be too good to be true often is.

Richard Feynman, the celebrated American physicist and a great teacher, said…

The first principle is that you must not fool yourself and you are the easiest person to fool.

One key lesson from the DLF fiasco for you is to remember this above quote. You are easiest person to fool, and the CEOs, investment bankers, and stock brokers know this for a fact.

Of course, cases like DLF pull a lot of investors out of the market as they are not sure whether they can wade through this jungle of fear and greed.

But if you are willing not to get fooled, you can have a great future as a stock market investor.

Here’s a final word from Buffett from his 1985 letter…

Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: “All I want to know is where I’m going to die so I’ll never go there.”

Cases like DLF are constant reminders to you that your first job as an investor is to avoid businesses that can kill your wealth – simply say ‘no’ to them – and then try to gain insights on the ones that can help you compound your wealth over the next 10-20 years.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. Sampat Bhansali says:

    Dear Vishal,

    Agree to your point, but, the Indian industry is in general filled with frauds, so best is to avoid stock market.

    Disclosure: I have only 1 stock in my portfolio and that is not DLF 🙂

    • Kamal Garg says:

      I agree that the blog post should forewarn about such fraudulent companies and their malpractices so that gullible investors are saved from their hard earned money and fraudsters. Can there be a mechanism by which we get prior warning or alarm bells about such companies. I think analysts and researchers should develop such a mechanism and share the finding with the public at large so as to benefit the society at large.

  2. Dear Vishal,

    I completely agree with your blog . But I guess it is bit challenging for individual investors like myself to know management with the limited information available in public domain. We get to hear CEO and other c-suite executives during annual meetings and few other times during the year .

    Do you feel it is enough for anyone to come to a conclusion about management ? Whereas FII and DII could have one to one interaction with gentleman, which gives them better understanding on management .

  3. I believe one of the best ways for a small investor to check management quality ( as a general rule , will be exceptions) is to check the consistency and track record of dividend payouts. As quoted , dividends are the only thing
    a company necessarily needs to write a check for.

    Also , avoiding companies which are politically-connected might be useful in the Indian context.Too many such comapnies have ended up destroying shareholder wealth.DLF, Satyam , KingFisher, Reliance , the list goes on…

  4. Kamal Garg says:

    Most of us are into the extreme trap of fear and greed. How great it would be to buy into stocks like Asian Paints, Marico, Pidilite , etc. (by the way, all are ‘desi’ companies). We are tempted by greed and buy into stocks like DLF or Unitech, etc.

  5. Parvin Worliwalla says:

    The article puts across and emphasizes that we need to form an opinion for the management (integrity and ability to excel and lead) .

    This becomes particularly important in the Indian context where we see family run businesses – all in the family forming the top layer of management and also the Board of Directors. In this scenario, management integrity becomes all the more important – “Alignment” of corporate managers with shareholders. Do they share both in upside as well as downside? Or Just upside? All too often, I have seen the latter being true.

    To me, Management compensation (salary,perks,etc and Commission all summed up) is one criteria that helps to give an idea. Management drawing fat commissions even in down years is something I have come across a lot many times. And I have never ever seen, the justification for this commission being discussed in the Annual Reports.

    Has anyone seen ARs where commission criteria are discussed? What could be the criteria? What measures do you use for understanding whether the total compensation is way too much or is justified?

  6. I would take a diametrically opposite view on the opportunity that DLF presents. By talking about “management” and “quality”, we are trying to look at DLF and talk about Nestle! We all know what it is, but I can also argue that it ain’t as bad as it seems to be … but that would mean real hard work (and not for this forum).

    If we take the writing and interviews of people like Joel Greenblatt, Benjamin Graham (the Lord himself), Jean Marie Evelliard or Walter Schloss, my view is that they lay great emphasis on portfolio construction for the individual investor. They focus on very simple things (P/E, P/BV, etc.) that can be understood by everyone and then building a widely diversified portfolio of such names (35 – 40 or even 100 – 200 as in the case of Graham and Evelliard). Graham even advocated this view in his last interview before his death. Greenblatt’s “magic formula” is a derivation of that philosophy.

    By this metric, a 1% or a bigger or smaller position, could be something that should be considered. How many of the Nifty 50 stocks today quote below tangible book (at historical cost)? If we are confident that the potential range of outcomes from DLF is more defensive, we could even size the position larger.

    Your emphasis on “management quality” to force fit DLF and Mungerisms-Buffetisms about management and quality here is off-track. Buffet himself has made poor choices in his career (think Solomon Brothers, David Sokol). For all Buffet’s on Derivatives, BH itself scrambled to revise the bilateral Puts it had sold on S&P 500 and benefited hugely from favourable treatment. (But we all like to see things in Black and White and the Sage is flawless, no?)

    I will not discuss the lazy points about “bankers” and “incentives”. You have fallen for the same trap.

    And think of the SEBI order for a moment – (1) SEBI had this information prior to the IPO and it did not act, (2) the decision to ban the company is damaging to non-management shareholders, (3) the interpretations on points of law and regulation are a bit here and there, etc. But this is a very legal thing and I’d think only a few on this forum would have even looked at the order. So not for this discussion.

    Nevertheless, great work in making people ask the questions (right questions?) … enjoy!

    • Apart from the few obvious cases like DLF, Jindal Steel, Jaiprakash etc its very tough to identify dishonest managments beforehand for the average investor. Usually midcaps and smallcaps with unscruplous managements create a lot of (temporary) wealth for investors before their truth is out in the open. For e.g. stocks like Opto Circuits, Gitanjali Gems, Deccan Chronicle, Satyam, FTIL (the list is long) and even PSUs like BEML, PSU banks etc made massive amounts of wealth for their shareholders before their gig was over. And it led investors to blindly believe in their managements. It was very difficult to act against the story the market was telling us. So it would be wise for investors to provide for the contigency that One out of Five companies in his portfolio will go bust and his entire investment investment in that stock will go to zero (or close to). Nevertheless, if his other 4 stocks double in value, his overall portfolio will be up 60%(assuming equal allocation in all stocks) which is not a bad result after all . And last but not the least, it would serve the investor well to remember Buffett’s quote from his 2013 letter – ”The difference between successful and very successful people is that the very successful say NO to almost everything”

  7. Divakar G Nayak says:

    Hi Vishal,
    Thanks for making us aware about the recent DLF fiasco
    I and other lay investors like me would greatly benefit from your article (given your experience in stock market ) if you could have shared with us on how to identify dishonest management and their malpractice rather than quoting Warren Buffet which doesn’t say about any specific tool method to judge the management

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