After Vakrangee and Manpasand, More Auditors May Soon Resign! Avoid these Stocks to Make Big Profits

Last week I wrote to you about Manpasand Beverages and how some super investors got it horribly wrong.

If you look for the biggest risk in the small and mid-cap space... corporate governance and the integrity of their accounts would top the list.

It is here that auditors play a crucial role.

However, historically, they have failed to raise red-flags in time.

And frauds are revealed - the auditors resign.

This is not the first time when cases like Vakrangee, Gitanjali Gems, Shilpi Cable, and Manpasand Beverages have emerged. The list is a long one.

However, I believe, this is just the beginning.

Did you know, so far in 2018, thirty-two auditors have already resigned?

In most of the cases, the main reason was non-disclosure of information by the companies. (More about this in today's chart of the day).

Are Auditors Forced to Exit?

The big question is - why are these resignations happening now? What has changed suddenly ? Are they being forced to exit?

Well, I can confirm that nothing has changed as far as company disclosures are concerned.

But there has been one big change that very few are talking about.

Enter, the National Financial Reporting Authority (NFRA) under the Companies Act 2013.

You may be aware dear reader, in India, the Institute of Chartered Accountants (ICAI) is the regulator for auditing and accounting standards.

ICAI is a self-governed body and regulates its own members (a monopoly) in India.

However, post the PNB fraud, the finance ministry approved an independent regulator for listed companies - the NFRA.

In simple words, the NFRA, an independent body, is the new regulator for auditing and accounting standards of listed companies and large public sector unlisted companies.

This move conforms with the global standards and has led to a strict control over auditors. This has led to the series of resignations.

There is a good possibility that the number of resignations in the small and mid-cap space may increase. This has struck fear in the minds of investors.

The smallcap index fell 19% from its peak.

Currently, 560 stocks are trading at 52-week lows. And most of these beaten down stocks are small caps.

Should you worry?

I believe, this can lead to some short-term pain but will help to improve corporate governance standards.

I understand there is a lot of fear in the minds of the aam investor. However, at the same time, I think these are exciting times for picking high-quality stocks.

For upcoming Smart Money Secrets recommendations, my team and I will meet more than twenty company managements in this AGM season (time when listed companies held their Annual General Meetings with its shareholders). These companies, I believe, have excellent corporate governance standards in place already.

And with the sharp correction in the market, I'm confident I can publish a some very good recommendations.

As far as frauds are concerned, I have my Smart Money Score to reject companies with suspicious numbers and practises.

By the way, this month for the first time, I'm considering a special situation as a Smart Money Secrets recommendation. I believe the upside in this stock is as high as 60%. Watch this space...

Chart of the Day

Talking about frauds and wrong corporate governance behaviour, the Companies Act requires every company to get its accounts audited by qualified chartered accountants.

In India, Institute of Chartered Accountants of India (ICAI), a self-regulatory body, governs the auditing and accounting standards.

Auditors are members of ICAI and they are governed by their own institute. It is believed, this has led to wrong incentives and frauds like Satyam, Manpasand, and Punjab National Bank.

However, with the recent PNB fraud the government took partial control from ICAI. The government in March 2018, notified the National Financial Reporting Authority (NFRA).

NFRA is the new regulator for auditing and accounting standards for listed and large public sector unlisted companies.

An independent regulator means tighter control over auditors and their reports.

Are Auditors' Exits a Turning Point for Mid & Small Caps?

Interestingly, this has led to a sharp increase in the number of auditors resigning in-between a financial year... a rare event, historically.

In the last one month, around fifteen auditors have resigned and for the period January to May the number stands at thirty-two. In fact, there is an increase in the 'qualified opinions' as well.

We at Smart Money Secrets, have always tried deciphering any such malpractices in the companies we analyse and the introduction of NFRA will help us in our endeavour.

We strongly believe, the introduction of NFRA is an important step to build up a transparent mechanism for accounting, auditing, and financial reporting. Thus, better corporate governance will lead to better-quality recommendations for our subscribers.

Regards,


Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

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