What Auditor Resignations Warn About Smallcaps 

32 auditors had resigned between January and May 2018.

The number may seem miniscule given the quantum of listed stocks.

However, what was alarming was the rationale of the resignations, which weren't in the normal course of audit contracts.

The role of auditors truly came under the spotlight when a big 4 audit firm (PwC) was found guilty of shadowing the massive corporate governance lapse at Satyam Computers in 2008.

The story repeated itself in 2018. While auditors were to play a crucial role in pointing red flags, they chose to turn a blind eye to some frauds. And when matters get worse, typically, the auditors resigned.

May cases of auditor resignations like that of Vakrangee, Gitanjali Gems, Shilpi Cable, and Manpasand Beverages emerged in 2018. The list is a long one.

And unsuspecting investors lost their hard earned money.

The story does not change in 2024. Once again if you look for the biggest risk in the small and penny stocks space, corporate governance and the integrity of their accounts would top the list.

Take the case of a much-hyped solar energy company Urja Global.

The steep triple digit valuation multiple does not give away much. Also, the stock went up 6 times between March 2023 and February 2024 before crashing by 50%.

Wondering why investors gave up on the stock so quickly? Lets delve deeper.

Urja Global is a renewable energy company that provides design, consultancy, integration, supply, installation, commissioning and maintenance of off-grid and grid connected Solar Power Plants. The company also claims to be an approved channel partner of Ministry of New and Renewable Energy (MNRE), Government of India.

The company manufactures Energy Systems with focus on rural electrification. This is especially for hilly areas, forest regions, deserts, islands, unmanned locations andother areas which require reliable and uninterrupted power supply.

As per company it has a network of 38 dealers, a sales & service team of almost 60, and approximately 10 m customers. The business model therefore definitely sounds potent given the massive scope for solar energy in India.

But most investors would be completely unaware of the company's past doings.

In 2019, Urja Global had informed the BSE about entering into an agreement with a Japanese company, Nippon Shinyaku to supply a product called Zacobite for five years. The cost of procurement was stated as US$ 65 m, with Urja pocketing a 10% commission.However, 'Zacobite' did not find a mention on either Urja Global or Nippon Shinyaku's website. It was not even mentioned in Urja Global's annual reports for three years. Zacobite did however boost the stock price.

Eventually it turned out that Zacobite does not exist.

Not on the Periodic Table, not even on a Google search.

That's right. The company decided to sell a product that does not exist!

That was not all.

On 7th June 2023, company entered into an agreement with Tesla Power India for manufacturing and supply of batteries under the Tesla brand. Further, it was supposed to utilize the Tesla Service centers for the promotion of theirEV battery service requirements.

Point to note here is that the Tesla mentioned here has no link to Elon Musk's company. Yet, the announcement has boosted the stock price by 20% in 2023.

In 2023, the CEO, the Auditor and the Company Secretary of Urja Global resigned within a matter of months of each other.

The stock price crashed by 50% following this development.

While Urja Global is now a penny stock, it continues to find takers amongst investors keen to buy into megatrends in the making.

Mind you penny stocks are not the only problem area.

Bulk of the action in stocks are in the primary markets these days. There are a dime a dozen IPOs soliciting investors with their fancy stories. The SME IPOs, in particular, have fetched plenty of attention in recent weeks.

Frail business models with limited or no visibility have been flying off the shelves in the SME IPO market.

Even the market regulator has warned investors about not buying into these fictional stories of very high growth too easily.

We certainly cannot paint every high growth company with the same brush. However, the pressure to report obscene growth numbers quarter after quarter to prevent market disappointment can take a toll.

Even seasoned managements of large companies are known to fall into such traps.

So, it cannot be denied that at least a handful of high growth businesses are trying to 'manage' their reported earnings so as to not disappoint large investors in the bull market.

Such companies could, in the worst case, also end up stepping on the wrong side of law in their frenzy to please shareholders.

Investors must not forget the cases like Vakrangee, Manpasand Beverages or for that matter IL&FS to warn themselves of not going overboard for growth.

Hope you like this video. Thanks for watching.