labels: finance - general, investment - general, stock markets - india, markets - general
Manipulated equity research reportsnews
Rex Mathew
28 March 2005

Do not trust the muck that goes around as equity research on small stocks as most of them are factually inaccurate and "prepared" with questionable intentions.


A bull market invariably sees the mushrooming of research analysts. Anyone, including your neighbourhood grocery shop owner seems to display a savvy analytical ability. There is no regulation or guideline by market watchdogs like SEBI covering equity research. Fundamental analysts, technical analysts and a new breed called techno-fundamental analysts are at hand to dispense advice to anyone willing to listen to thwem. During a bull run when stocks are the flavour of the season, the media also gives them a ready.

As most of the visible and heard of stocks appreciate substantially, everyone searches for new ideas. Once stories dry up in frontline stocks, one way out for an analyst is to stretch an old idea. The concept of replacement value proposed by the late Harshad Mehta is a classic example of stretching an old idea.

When many of his favourite stocks had run up substantially and people had begun started questioning their valuations, Mehta came up with replacement value as a method of choosing scrips. He said his favourite stocks had to go up further as setting up new companies with similar capacities would cost much more than the market values of the existing companies.

This and similar ideas sound logical to many small investors, especially when they come from supposedly knowledgeable analysts. If the investors think for themselves, they would realise that existing companies would have old depreciated assets, low in efficiency and value, and it is not the assets per se but the return generated on those assets that matter.

Stretching an old idea is not easy anymore as there are large investment houses, both domestic and foreign, who cover the frontline stocks with detailed first hand research. Though big research houses are not infallible, they are more careful not to repeat the excesses of the dot com days when websites were valued on strange and exotic parameters.

Generally, the quality of research by major broking houses has improved vastly from the last bull market. Many of them employ qualified analysts and who spend more time in real analysis than fishing out data. It also helps that information flow from companies, too, has improved substantially in line with disclosure standards. These days even a lay investor can gather enough information about frontline companies without as much effort or time till a few years back.

When it comes to the thousands of small companies listed mostly on the Bombay Stock Exchange, everything remains more or less as it was in the '90s. Many of these companies are unheard of and nearly defunct. Managements are not very forthcoming on information and they reveal the bare minimum required under guidelines imposed by SEBI and the stock exchanges. Many small, listed companies are in minor business segments making it difficult to understand their operations and prospects. Big investment brokerages don't cover these companies. This creates the perfect scenario for anyone who wants to make a living as an equity analyst. One-man boutique research firms descend on this opaque universe of small cap companies in search of the next big stock story which can multiply five times or 10 times.

Recently, a research report on Tata Teleservices Limited (TTL) by an equity research firm was published on one of the country's most popular websites. Tata Teleservices Ltd is a Tata group company engaged in the business of fixed and mobile telephone services under the brand name Tata Indicom. The report is neatly presented, the language is good and has a professional feel to it.

It talks admiringly about the rapid strides made by the company in expanding its network all over India and the quantum jump in subscribers. It also talks very knowledgeably about the technology platforms offered, technical tie ups with global companies, the array of services offered, etc. The report concludes with a buy recommendation on TTL at Rs30 per share and a statement that the stock could multiply in value as the company is planning to quadruple its customer base across the country.

Everything the report says about TTL is true and many telecom industry observers would agree that the company has good potential. Unfortunately, the Tata Teleservices Ltd the report is talking about is not a listed company. It is a privately held company promoted by Tata Industries Ltd and some other group companies. The listed company, Tata Teleservices Maharashtra Limited (TTML), is a subsidiary of TTL and its share price is around Rs30. It was called Hughestele.com before being acquired by the Tatas and operates the Maharashtra and Goa telecom circles only.

With a subscriber base of 5 lakh, TTML is at least a few years away from being profitable at the net level and has huge borrowings in its books. Even then, TTML has a market value of over Rs4,000 crore and is overvalued when compared to a highly profitable telecom company like Bharti with 20 times TTML's subscriber base and valued at less than Rs40,000 crore. Imagine the plight of someone investing on the basis of this report and on the false impression that Tata Teleservices has an all India presence.

In this case, the analyst may not have had any malafide intentions and it could be a genuine mistake out of inexperience. At least the analyst is talking about a company belonging to a well known group and the facts can be cross-verified if necessary.

There are other reports which arouse serious doubts about the intentions of analysts. Such reports, which are also published by general websites and sometimes on the websites of stock brokerages, talk only about obscure companies whose stock prices are in single digits or low double digits.

A common theme in such reports is about existing companies going for debt restructuring and possible investments by institutional investors. Another theme is companies diversifying into new businesses like biotechnology, IT-
enabled services, etc, irrespective of whether they have the capabilities to manage or even survive in such businesses. The analyst is usually dependant on the management of the company for details tpo base the report on. Unlike a known company, an average investor has no way to verify the information contained in such analyst reports as there is hardly any reliable data about such companies in the public domain.

Many of these reports are freely available to anyone who has the time to read them. Why should these analysts provide their services to investors free of charge? After all, if they had put in their effort in researching the company such efforts would have cost money. The answer is evident in the disclaimer note analysts have been forced to add to every report. If one read the disclaimers, more often than not, the analyst would be holding positions in the stock mentioned.

But, lay investors hardly read the fine print at the bottom. When they do, they gloss over any thing getting in the way of their conviction that they are about to get to get into a dream stock. The stock shoots up after the report is published as retail investors rush in to buy. The analyst and other 'investors' unload their holdings at a profit. As soon as the stock starts dipping, panic sets in among retail investors and the stock crashes as everyone tries to get out. Meanwhile, the analyst moves on in search of his next diamond in the coal mine.

What can SEBI or the exchanges do about this? Research and analysis are subjective and based on the judgement of even serious analysts and as such it would be extremely difficult to set standards for such an. But SEBI and the exchanges can at least consider the following steps to begin with.

  • All analysts who wish to publish research reports on stocks in the public domain should be registered with SEBI
  • Minimum professional training levels should be prescribed for registration of analysts. Alternately, they may be asked to clear a qualifying examination to be conducted by SEBI
  • Analysts or their clients should not hold any position in the stock at the time of publishing the report
  • SEBI and exchanges should ensure better reporting standards from smaller companies and ensure that the data available is sufficient and accurate
  • Company managements should be asked to disclose to exchanges all information they provide to analysts. Exchanges should make such information available to all potential investors through their websites
  • SEBI should advice the media to set internal standards for ensuring quality of published research reports

Till the market watchdog and the exchanges wake up to issue, small investors would do well to read research reports with circumspection. If you decide to invest on the basis of such reports do remember that they all come with an unstated disclaimer; 'This report may have been prepared with the intention of misleading the reader and for the monetary benefit of the author and his friends. Consume at your own risk'.

*A professional cost accountant, the author is a stock analyst and indepenent market trader

Disclaimer: The author doesn't have any position in the stocks specifically mentioned above at the time of writing this article. This analysis/report is only for the purpose of information and is not an investment advice. Readers are advised to consult a certified financial advisor before taking any investment decisions. While efforts have been made to ensure the accuracy of the information provided in the content the author or publisher shall not be held responsible for any loss caused to any person whatsoever.

also see : Games promoters play
The lurking danger of a small stock bubble

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Manipulated equity research reports