Why Quality of Management and Corporate Governance Matter in Stock Investing

Recent News: SEBI’s Ban on Mishtann Foods: In a significant move, SEBI (Securities and Exchange Board of India) has barred Mishtann Foods Limited (MFL) and its key directors from accessing the stock markets. The action stems from alleged financial mismanagement, fraudulent transactions, and corporate governance lapses.

What Did SEBI Find?

SEBI’s investigation revealed a series of troubling practices by Mishtann Foods:

• Fake Entities and Circular Trading: Over 90% of the company’s sales and 84% of its purchases were found to be fake. These transactions involved circular money flows through shell companies controlled by the promoters.
• Rights Issue Misuse: Nearly Rs.75 crore raised through rights issues was diverted to non-operational entities linked to the company’s promoters.
• Misleading Financials: The company inflated its sales and purchases on paper, misleading investors about its financial health.
• Promoter Offloading Shares: Hiteshkumar Patel, the managing director and sole promoter, offloaded shares worth Rs.50 crore, further reducing his stake.

SEBI’s order emphasizes how such practices undermine investor trust. It disrupts market integrity, and harm retail investors, who often lack the tools to uncover such malpractices.

Why This News Matters to Investors

Investing in stocks isn’t just about looking at profits, revenue, or market capitalization. It’s about understanding who runs the company and how.

Mishtann Foods is a classic example of what can go wrong when management integrity and corporate governance are compromised.

What Is Corporate Governance?

Corporate governance refers to the set of rules, practices, and processes that direct and control a company. It ensures accountability, fairness, and transparency in a company’s relationship with stakeholders.

In simpler terms, it’s about how companies make decisions and how they treat their stakeholders.

Why Quality Management and Corporate Governance Matter

1. Management Drives the Company’s Future

Imagine travelling on a bus company where the driver is reckless and ignores the rules. Would you feel safe? Similarly, in a company, management acts as the driver, steering the business towards growth or disaster.

Example: Warren Buffett, one of the world’s greatest investors, emphasizes management quality in his investment decisions. He often says, “I invest in people, not just businesses.”

• Good management makes decisions that create long-term value.
• Poor management, as seen in Mishtann Foods, can erode shareholder wealth through mismanagement or fraud.

2. Corporate Governance Protects Shareholders

Good governance ensures that a company’s board and executives act in the best interest of all stakeholders, especially shareholders. It establishes checks and balances to prevent unethical practices.

How SEBI’s Action Highlights Governance Failures:

• Mishtann Foods’ directors failed to fulfill their duties.
• Financial statements were manipulated for seven years.
• Funds raised from the public were misused.

This case highlights why investors should scrutinize governance practices before investing.

3. Transparency Builds Trust

When companies disclose accurate and timely information, it allows investors to make informed decisions. Mishtann Foods inflated its financials, hiding the reality from investors.

Lesson for Investors: Always verify whether a company’s financial statements are audited and check its track record for transparency. Look for red flags like sudden jumps in revenue or profits without corresponding growth in assets or cash flows.

4. Impact on Retail Investors

Retail investors often bear the brunt of corporate fraud.

In Mishtann Foods’ case, the number of public shareholders rose from just 516 in FY18 to 4.23 lakh in FY24.

Many of these investors were likely lured by the company’s artificially inflated performance.

My Perspective: This incident reinforces the need for retail investors to look beyond the hype. Avoid chasing stocks just because they are gaining popularity or showing rapid price increases. Always question how and why the growth is happening.

How to Identify Good Management and Governance

Here are some tips for evaluating a company’s management and governance:

1. Check Management’s Track Record: Research the past decisions of the company’s leadership. Have they delivered on promises?
2. Review Annual Reports: Look for transparency and detailed disclosures. Avoid companies that use vague or overly complex language to describe their operations.
3. Study the Shareholding Pattern: Stable promoter holding and low pledging of shares are positive signs. Frequent offloading by promoters, as seen in Mishtann Foods, is a red flag.
4. Monitor Related Party Transactions: Excessive dealings with group companies or shell entities are often signs of misuse.
5. Understand Governance Policies: Does the company have independent directors? Are audit committees active?

Honest Confession:

Most of the stock analysis algorithm’s rely heavily on financial reports published by companies (including mine – The Stock Engine). As these reports are audited by authorized third-part Auditors, in majority cases, the published numbers (especially of listed companies) are very reliable. But if these numbers itself are false, even a deep algorithm can fail to find the disparity.

I would like to admit that my Stocks Engine’s algorithm was also giving a very high score to this company. As SEBI has reported, The company has been manipulating its financial reports since last seven years in a row, the algorithm missed to pick the error.

Though I would also like to humbly say that the same algorithm is now pointing towards potential goods stocks like Britannia, Asian Paints, PI Industries, etc. But I must accept that my algorithm must find a way to deal with such issues.

Conclusion

The SEBI ban on Mishtann Foods is a wake-up call for retail investors.

It reminds us that stock investing isn’t just about picking companies with high profits or low P/E ratios. It’s about assessing the people behind the business and ensuring they operate with integrity.

As an investor, we must always prioritize companies with strong governance, transparent practices, and ethical leadership.

While such companies may not promise quick gains, they are more likely to create sustainable wealth over the long term.

Final Thought

In stock investing, the quality of management and corporate governance isn’t a luxury, it’s a necessity.

Always do your own due diligence. A small effort today can protect you from significant losses tomorrow.

What’s your take on this topic? Have you encountered similar red flags in companies you’ve researched? Share your thoughts in the comments below.

Have a happy investing.