Accounting Thematic - Ambit

Strategy
November 2013
Accounting Thematic
Gaurav Mehta, CFA gauravmehta@ambitcapital.com Tel: +91 22 3043 3255 Karan Khanna karankhanna@ambitcapital.com Tel: +91 22 3043 3251
Accounting quality drives alpha
Saurabh Mukherjea, CFA saurabhmukherjea@ambitcapital.com Tel: +91 99877 85848
Strategy
CONTENTS
Strategy: Accounting quality drives alpha.. 3 Methodology. 4 Accounting quality and investment returns - Absolute scores 6 Accounting quality and investment returns - Change in scores..10 Myths around accounting quality..................................................................13 Sample bespoke - World Cargo.. 16
22 November 2013
Ambit Capital Pvt. Ltd.
Page 2
Strategy
THEMATIC November 22, 2013
Sector-neutral accounting buckets show strong link between accounting quality and investment returns
Accounting bucket Accounting Share price score performance
Accounting quality drives alpha

Forensic accounting has been a key component of our research over the last few years. Our forensic accounting model allows investors to screen the BSE500 through proprietary tools which provide a quick assessment of the health of their portfolios. Such a health check is essential given the strong influence of accounting quality on shareholder returns: the top decile of BSE500 stocks on accounting quality outperforms the bottom decile by 26% per annum. Quantifying accounting quality Our model looks at the following key categories of accounting irregularities: balance sheet misstatement, profit & loss misstatement, cash pilferage and audit quality. We use 11 ratios across these categories to quantify the accounting quality for the BSE500 stocks (excluding banks and financial services firms). The caveat, however, is that whilst these aggressive accounting policies raise red flags, they may not necessarily imply accounting fraud. Accounting quality drives investment returns Our analysis suggests that accounting quality is a significant driver of stock returns in India. Deciles constructed based on accounting scores show a tight relationship with stock price performance, with D1 (i.e. the top 10% of BSE500 stocks on accounting quality) outperforming D10 by a whopping 26% CAGR since April 2007. Importantly, the conclusion holds true even after controlling for sector effects (i.e. sector effects or business model effects are NOT driving this outperformance see the table in the right margin). Furthermore, even within a sector, we find that accounting quality has a major bearing on share prices see the chart on the right.
Accounting quality drives investment performance 20%
Average share price performance
Bucket A Bucket B Bucket C Bucket D
227 198 176 146
8.8% 7.7% 4.7% -2.5%
Source: Ambit Capital research, Bloomberg
Accounting quality versus share price performance for the Utility sector
20%
Share price performance
R = 52%
10% 0% 100 -10% -20% -30% Accounting score 200 300
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY08-13; stock price performance is from April 2007 to November 2013.
R = 84% D6 D7 D8 150 D9 D10 Average decile accounting score 200 D5 D4 250 300 D2 D3 D1
15% 10% 5% 0% 100 -5% -10% -15%
Analyst Details
Gaurav Mehta, CFA +91 22 3043 3255 gauravmehta@ambitcapital.com Karan Khanna +91 22 3043 3251 karankhanna@ambitcapital.com Saurabh Mukherjea, CFA +91 22 3043 3174 saurabhmukherjea@ambitcapital.com
How can we help? Our forensic accounting model allows us to conduct a first-level health check of your portfolio and helps identify potential red flags in your portfolio. This is a critical input to both our Good & Clean portfolios as well as to our bottom-up research coverage. On a bespoke basis for clients, we also supplement these screen-driven red flags with bottom-up investigative research on individual companies. Please contact your Ambit sales representative in case your portfolio has not been screened yet by our forensic accounting model.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Strategy
Methodology
We use 11 ratios to score the BSE500 universe of firms (excluding, banks and financial services firms) based on their accounting qualities. These ratios can broadly be categorised into four buckets.
Exhibit 1: Key categories of accounting checks Category Ratios (1) CFO/EBITDA, (2) change in depreciation rate, and (3) non-operating expenses as a proportion of total revenues. (1) Cash yield, (2) change in reserves (excluding share premium) to net income excluding dividends, (3) provisions for doubtful debts as a proportion of debtors more than six months, and (4) contingent liability as a proportion of net worth. (1) CWIP to gross block, and (2) cumulative CFO plus CFI to median revenues (1) Audit fees as a proportion of standalone revenues, and (2) audit fees as a proportion of total auditors remuneration
P&L misstatement checks
We focus on four categories of accounting checks: P&L misstatement, Balance sheet misstatement, cash pilferage and audit quality.
Balance sheet misstatement checks
Cash pilferage checks
Audit quality checks

Source: Ambit Capital research
Here is a brief description of the accounting ratios:
I - P&L misstatement checks

1 CFO/EBITDA: This ratio checks a companys ability to convert EBITDA (which can be relatively easily manipulated) into operating cash flow (which is more difficult to manipulate). A low ratio raises concerns about the companys revenue recognition policy (because this may imply aggressive revenue recognition through methods such as channel stuffing). We use a six-year median for this measure. Change in depreciation rate: We calculate change in depreciation rates for each of the past six years (FY08-13). We then calculate the median of absolute changes and then sort the companies on this ratio such that the company with the smallest change in its depreciation rate receives the best score. The rationale is to penalise companies that have high volatility in their depreciation rate on a YoY basis. Non-operating expenses as a proportion of total revenues: This ratio checks a companys expenditure policy. A high ratio raises concerns on the authenticity of such expenses. We use a six-year median for this measure. A total of eleven ratios encompassing the four categories of checks are used to score BSE500 firms on their accounting quality.
II - Balance sheet misstatement checks

4 Cash yield: This ratio is calculated as the yield earned on cash, investments and deposits. A low ratio could be a cause for concern, as it could mean that either the balance sheet has been misstated or that the cash is not being used in the best interests of the firm. We use a six-year median for this measure. Change in reserves (excluding share premium) to net income excluding dividends: This ratio is calculated by dividing the change in reserves (excluding share premium) on a YoY basis and dividing it by that years PAT excluding dividends. We then take a six-year median of this ratio. A ratio less than one indicates direct write-offs to equity without routing these through the Profit & Loss account and may indicate aggressive accounting policies.
November 22, 2013
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Strategy 6 Provision for doubtful debts as a proportion of debtors more than six months: This ratio checks a companys provisioning policy. A low ratio raises the spectre of earnings being boosted through aggressive provisioning practices. We use a six-year median for this measure. Contingent liabilities as a proportion of net worth: This is a check on a companys off-balance-sheet liabilities. If this ratio is high it raises concerns on the strength of the companys balance sheet in the event that the contingent liabilities materialise. Given that contingent liabilities also include genuine items such as letters of credit, guarantees, bill discounting and capital commitments, we eliminate them whilst computing the figure for contingent liabilities. We use a sixyear median for this measure.
III - Cash pilferage checks

8 CWIP to gross block: We calculate the proportion of capital work in progress to gross block for each of the last six years and take a median. A high ratio is penalised; the idea is to punish firms that show consistently high CWIP relative to gross block, as this may indicate either unsubstantiated capital expenditure or delay in recognition of depreciation expense. We use a six-year median for this measure. Cumulative CFO plus CFI to median revenues: We calculate the cumulative CFO (cash flow from operations) plus cumulative CFI (cash flow from investing activities) over the last six years and divide this by the last six-year median revenues for the company. Higher the ratio, the better. The idea is to penalise firms which over such large periods have been unable to either generate positive cash flows from operations or alternatively where cash flow from investments have consistently eaten away cash generated from operations.
List of firms whose FY13 data is not available (cut-off date is 5th Nov)
Company ABG Shipyard Alok Inds. Financial year end Mar Mar Jun Jun Sep Jun Sep Mar Sep Mar Mar Mar Mar Mar Mar Jun Jun Jun Mar Dec
IV - Audit quality checks

10 Audit fees as a proportion of standalone revenues: We calculate standalone audit fees as a proportion of standalone revenues for all the six years (FY08-13). A lower ratio receives a high score. The rationale is to penalise companies which are paying their auditors too much as compared to their revenues. We use a sixyear median for this measure. 11 Audit fees as a proportion of total auditors remuneration: A low proportion of audit fees to total remuneration paid to that auditor indicates that the share of audit in the total business that the auditor derives from the firm is low and may be a cause for caution. Again, we use a six-year median for this measure. Cumulating scores: We cumulate scores across these 11 parameters to arrive at the final accounting score for each firm. Based on these parameters, we rank 374 firms on accounting quality in this years forensic exercise. We have excluded 84 banks and financial services firms. Another, 20 firms are excluded because their FY13 annual reports have not been published (see table on the right). A further 22 firms are excluded due to sketchy data availability/corporate restructuring/year-end change/limited listed history. Data sources: We have used Ace Equity and Capitaline as data sources for the underlying financial data whilst stock price data has been sourced from Bloomberg. We had to use Ace Equity for some data items and Capitaline for some others in order to minimize data errors to the best of our understanding. Unfortunately neither is entirely reliable by itself. Please note, however, that several adjustments need to be made to each of the individual variables which we have not detailed here. For further details on these adjustments, kindly email the authors of this note
Amtek Auto Amtek India Bajaj Hindusthan Ballarpur Inds. BF Utilities Elder Pharma Escorts HMT KGN Enterprises Monnet Ispat Orchid Chemicals Parsvnath Devl. Pipavav Defence P & G Hygiene Rolta India Symphony Turbotech Engg. Videocon Inds.
Source: Ace Equity, Ambit Capital research Note: For the purpose of this exercise, we have included HCL Technologies (June ending), MRF and Siemens (September ending) based on their FY07FY12 financials.
November 22, 2013
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Strategy
Accounting quality and investment returns

Absolute scores
In this section, we seek to answer the following question: Does accounting quality, as quantified by our model, impact stock market performance? For this we assess the link between the blended forensic accounting scores for the BSE500 universe of firms, derived based on the methodology explained above using the last six years data, and the stock price performance for these stocks from April 2007 to November 2013. 1. Universe level: We find that for the BSE500 universe as a whole, stock-specific accounting scores and stock price returns do not have a significant relationship (see the exhibit below). Such a lack of correlation is not surprising given the multitude of other factors (such as the underlying fundamental performance) which influences stock price returns.
Exhibit 2: Scatter plot of accounting scores vs stock price performance for all BSE500 stocks does not bring out any significant relationship 100%
80% 60% 40% 20% 0% 50 100 150 -20% -40% -60% Accounting score 200 250
R = 14%
300
Stock level noise leads to weak relationship between accounting scores and stock returns at the universe level (374 firms)
2. Decile level: To control for noise around individual stocks, we arrange these stocks into deciles based on their accounting scores. We then find a strong relationship between the average accounting scores of these deciles and the average stock price performance of their constituent stocks, suggesting that accounting quality is a significant driver of stock returns.
Exhibit 3: Decile-level analysis points to a strong link between accounting scores and stock price performance 20% 15%
R = 84% D2 D6 D7 D8 120 140 160 D9 D10 Average decile accounting score 180 200 D5 D4 220 240 260 D3 D1
however, deciles constructed on accounting scores demonstrate the power of accounting quality in shaping stock returns
10% 5% 0% 100 -5% -10% -15%
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accouting score is based on annual financials over FY08-13; stock price performance is from April 2007 to November 2013.
November 22, 2013
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Strategy In terms of individual decile performances, the first decile (D1) has delivered stock price returns of 13.4% CAGR since April 2007 whilst the last decile (D10) has delivered returns of -12.6% CAGR over this period, thus implying a close to 26% CAGR outperformance for D1 vs D10. The performance differential across deciles becomes more evident from exhibit below.
Exhibit 4: Decile-level analysis suggests accounting quality is important 15%
10% 5% 0% -5% -10% -15% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10
Top accounting decile outperforms the bottom decile by 26% on a CAGR basis
Accounting score based deciles
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY08-13; stock price performance from April 2007 to November 2013.
3. Sector-agnostic buckets: One may argue that in the decile construction above, sector effects have not been nullified and some sectors may do better than others on our accounting model by virtue of the nature of their businesses. The decile performances thus might reflect serendipitous sector effects. To control for the sector effects, we now construct four sector-agnostic buckets such that bucket A comprises the first quartile of each sector on accounting scores, bucket B comprises the second quartile of each sector, bucket C comprises the third quartile of each sector and bucket D comprises the last quartile of each sector. Hence, every bucket has an equal number of stocks from each sector, implying that the buckets are sector agnostic. Each bucket in this case will have similar sectoral compositions and hence a performance assessment of these buckets should enable one to assess the impact of accounting quality on stock price performance in a sector-agnostic manner. Exhibit 5 below displays these four buckets with their respective stock price performances. Clearly, the performance differential points to a strong link between accounting quality and stock price performances even after controlling for sector effects.
Exhibit 5: Strong link between accounting quality and stock performance even after controlling for sector effects (the first entry is the accounting score over FY08-13, the second entry is the avg CAGR stock returns in that bucket from Apr 2007 to Nov 2013) 10%
Average price performance
227, 8.8% 198, 7.7% 176, 4.7%
8% 6% 4% 2% 0% -2% -4% A
Sector agnostic buckets constructed with homogenous sectoral make and differentiated only on accounting quality show accounting quality drives investment performance even after controlling for sector effects.
D 146, -2.5%
Sector neutral accounting buckets
November 22, 2013
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Strategy 4. Sector level: Next, arranging BSE500 firms into sectors and assessing the link between the average accounting scores of these sectors and the average stock price performance of their constituent stocks suggests that accounting quality makes a difference at the sector level as well (i.e. sectors with higher accounting quality, such as Auto, Cement, and Consumer, perform better than sectors with poor accounting quality such as Realty, Engineering & Construction, and Infrastructure). However, this relationship is not as strong as the decile analysis in point 2 above.
Exhibit 6: Link between accounting quality and stock price performance at the sector level is moderate 40%
Consumer Durables FMCG Agro Fertilizers Industrials Auto Auto Anc Logistics 220
R = 29%
30% Retail Textiles Conglomerate 140 150 E&C Realty 160 Infra Miscellaneous 170 Pharma 10% IT 20%
Chemicals Cement
Oil&Gas 0% Metals Media Utilities 180 190 200 210 Cap -10% Goods Telecom Shipping -20% Average accounting score
Mining 230
With an average score of 218, Auto is amongst the best sectors in our accounting model. The sector has generated average stock price returns of 20% CAGR over the last six-year period since April 2007. On the other hand, Realty is the worst sector on accounting on our model with an average score of 150. The average stock price performance in the sector has been -15% CAGR over the last six-year period. Also, stocks within the same sector exhibit a significant link between accounting scores and stock price returns in many cases. Three sectors which show strong links are Utilities, Engineering & Construction and IT.
Link between accounting scores and price performance is moderate at the sector level
Exhibit 7: Within the sector, the link between accounting and price performance Utilities 20%
R = 52%
15% 10% 5% 0% 100 150 -5% -10% -15% -20% -25% Accounting score 200 250 300
however, within a sector stock returns show significant dependence on accounting scores
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score is based on annual financials over FY08-13; stock price performance from April 2007 to November 2013.
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Strategy
Exhibit 8: Within the sector, the link between accounting and price performanceE&C 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% R = 39%
50
100
150
200
250
300
Accounting score
Exhibit 9: Within the sector, link between accounting and price performanceIT 50%
R = 38%
40% 30% 20% 10% 0% 50 100 150 -10% -20% -30% -40% Accounting score 200 250 300
5. Size buckets: Finally to address the size dimension, we split our universe of stocks into four size buckets, as shown below. Bucket 1 comprises the largest 50 stocks on market cap, Bucket 2 of the next 100, Bucket 3 of the next 100 and Bucket 4 of the lowest 124 stocks on market cap (thus, taking the total to 374 firms).
Exhibit 10: Larger capitalisation firms have better accounting scores on average Bucket Bucket 1 Bucket 2 Bucket 3 Bucket 4 Number of firms in the bucket top 50 next 100 next 100 remaining 124 Market cap range (INR bn) `256-4,000bn `40bn-244bn `15.7bn-39.5bn `1.1bn-15.7bn Market cap range (USD bn) US$4.2bn-65bn US$0.6bn-4.0bn US$0.3bn-0.6bn US$0.02bn-0.3bn
Accounting quality is better for larger caps on average
Avg accounting score 210.9 191.5 184.5 174.7
Avg share price performance 11.3% 10.9% 7.8% -5.6%
As one would expect, we find that the average accounting score as well as the stock price performance varies directly with market cap, i.e. the largest market cap bucket has the best accounting score as well as the best stock price performance and so on.
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Strategy
Accounting quality and investment returns

Change in scores
The decile level and sector-agnostic buckets from the previous section suggest that accounting quality is a significant driver of stock prices and that this holds true even after controlling for sector effects. In this section, we seek to answer the question: Does a change in accounting score impact stock market performance? To calculate the change in accounting score, we break the six-year period (from FY08 to FY13) that we have used so far to calculate absolute accounting scores into two sub-periodsFY08-10 and FY11-13. We then use the 11 parameters to quantify accounting scores for each of the two sub-periods separately using the same methodology as earlier (but for a three-year period now vs a six-year period earlier). Change in accounting score is calculated as the change in the FY11-13 sub-periods score over the FY08-10 sub-periods score. Finally, we assess the link between this change in accounting score for the BSE500 universe of firms and the stock price performance for these stocks from April 2010 to November 2013. 1. Universe level: We find that for the BSE500 universe as a whole, the change in accounting scores and individual stock prices do not have a meaningful relationship (see the exhibit below). Such a lack of correlation is not surprising given the multitude of other factors (such as the underlying fundamental performance) which influences stock price returns.
Exhibit 11: Scatter plot of change in accounting scores vs stock price performance for all BSE500 stocks does not bring out any significant relationship 160%
With accounting quality showing strong link with stock price performance, change in accounting quality is another dimension meriting attention
120% 80% 40% 0% (150) (100) (50) -40% -80% Change in score (FY11-13 over FY08-10) 50 100
R = 1%
Again stock level noise prevents any strong link between change in accounting scores and stock performance
150
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for the FY10-13 subperiod over FY08-10; stock price performance is from April 2010 to November 2013.
2. Decile level: Similar to the methodology used in the preceding section to control for noise around individual stocks, we arrange these stocks into deciles based on their accounting scores. Arranging these stocks into deciles based on the change in accounting scores points to a moderately strong relationship between the change in accounting scores of these deciles and the average stock price performance of their constituent stocks.
November 22, 2013
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Strategy
Exhibit 12: Decile level analysis points to some link between the change in accounting scores and stock price performance but only a moderate one 12% 8% 4% 0% -80 -60 -40 -20 -4% -8% -12% Average change in decile score
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for the FY10-13 subperiod over FY08-10; stock price performance is from April 2010 to November 2013.
R = 33%
20
40
60
80
3. Market and sector level: Surely, when one is looking at changes in accounting scores over time, one is keen to know: (1) At the market level, are accounting ratios improving or worsening over time? (2) At the sector level, are accounting ratios improving or worsening over time? In the exhibit below, we highlight the proportion of ratios that are improving over time (i.e. in the FY11-13 period vs the FY08-10 period). It is heartening to see that on aggregate 70% of ratios have improved for India Inc.
Exhibit 13: Improvement in accounting ratios at the overall market and sector level
Sector Universe Auto Anc Media Auto Cement Infrastructure Logistics Pharma Retail IT Realty Agro Capital Goods Chemicals Consumer Durable Fertilizers Oil & Gas Shipping Telecom Conglomerate Engineering & Construction FMCG Industrials Metals Mining Utilities Textiles Source: Ambit Capital research, Bloomberg Proportion of ratios improving (FY11-13 over FY08-10) 70% 80% 80% 70% 70% 70% 70% 70% 70% 60% 60% 50% 50% 50% 50% 50% 50% 50% 50% 40% 40% 40% 40% 40% 40% 40% 30% Stock price CAGR since April 2010 18% 2% 17% 1% -22% 6% 12% 18% 4% -12% 13% -8% 12% 18% 4% -9% -25% -5% -13% -24% 26% -3% -20% -16% -16% 14%
Auto Anc, Media, Auto, Infra are amongst the most improved sectors on accounting quality
while Textiles, Mining, Utilities, FMCG and E&C show deterioration
November 22, 2013
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Strategy At the sector level, the ratios of Auto Ancillaries, Media, Auto, Cement and Infrastructure have improved. Utilities, Textiles, Metals & Mining and Engineering & Construction bring up the rear of this table, as most ratios have deteriorated for these sectors. 4. Size buckets: Finally, we split our universe of stocks into four size buckets exactly in accordance with the method described in the preceding section. We find that the improvement in accounting scores is the most for the lower market cap buckets.
Exhibit 14: Not much of a link between capitalisation and change in accounting scores
Bucket Number of firms in the bucket Market cap range (INR bn) `256bn-4,000bn `40bn-244bn `15.7bn-39.5bn `1.1bn-15.7bn Market cap range (USD bn) US$4.2bn-65bn US$0.6bn-4.0bn US$0.3bn-0.6bn US$0.02bn-0.3bn Proportion Average stock of ratios price improving performance 50% 60% 70% 70% 8.1% 6.2% 6.9% -14.2%
Bucket 1 top 50 Bucket 2 next 100 Bucket 3 next 100 Bucket 4 remaining 124
Source: Ace Equity, Capitaline, Bloomberg, Ambit Capital research; Note: Accounting score change is for the FY10-13 subperiod overt FY08-10; stock price performance is from April 2010 to November 2013.
Overall, here are some of the key findings from an analysis of accounting quality change over time: At the universe level, the accounting quality of India Inc seems to be improving. At the sector level, Auto Ancillaries, Media, Auto, Cement and Infrastructure have improved the most. At the sector level, Utilities, Textiles, Metals & Mining, FMCG and Engineering & Construction have deteriorated the most. Improvement in accounting ratios is more prominent for lower market cap stocks.
Improvement in accounting is most for lower capitalization stocks helped by a lower base to start with
November 22, 2013
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Strategy
Myths around accounting quality

We now turn to some common myths around accounting quality that we have encountered over the years and show why they are incorrect. Myth 1: Accounting quality is secondary to published financial results. We have long believed that accounting score is a better indication of a firms underlying health than the published results, especially in a market like India where the term independent auditor is often an oxymoron given that the auditor is, in effect, compensated by the promoter (rather than by the minority shareholder). In this regard Financial Technologies stands as an interesting example. Over the past several years, this company has received low scores in our forensic accounting model. However, based on the reported financials, the firm has shown 24% EPS CAGR and 33% BVPS CAGR since FY07. Using our forensic accounting model, we find that amongst the key drivers of Financial Technologies low accounting scores are a high proportion of non-operating expenses to total revenues along with a consistently negative and high CFI with respect to CFO. Myth 2: The market already knows and discounts firms which have poor accounting quality. After all Satyam did trade at a P/E discount to Infosys and Wipro before the promoter owned up to aggressive accounting. However, the stock still crashed by over 90% within two days of the fraud being made public. We also find no correlation between P/E and accounting scores at the market level nor do we find anything significant at an intra-sector level. The market simply does not know which companies books are cooked.
Exhibit 15: No correlation between accounting quality and P/E at the market level 120 100
trailing P/E
Accounting quality is a better indication of a firms health than the published results
Accounting quality has predictive power
Exhibit 16: No correlation between accounting quality and P/E for E&C stocks 60 R = 2%
R = 1%
trailing P/E
80 60 40 20 0 50 150 Accounting score 250
40
20 0 50 100 150 200 Accounting score 250 300
Source: Company, Ambit Capital research
Source: Company, Ambit Capital research
Myth 3: In sectors such as E&C, Utilities and Capital Goods, weak accounting quality is a certainty. Several firms in these sectors have accounting scores that are far superior to the market average, including Elgi Equipment, Cummins India, Thermax, Engineers India, NTPC, Gujarat Gas and Torrent Power. Myth 4: Nifty firms have good accounting quality. Whilst size bucket 1 (Exhibit 10 on page 9) has the best accounting scores, this overall average hides a great deal of variation. For example, the accounting scores of 33% of Nifty firms are well below the market average. For the weakest five of these firms, the accounting scores are actually so low that these firms are in the lowest three deciles of accounting quality for the BSE500.
Not all firms from E&C, Utilities and Capital Goods have weak accounting
and not all firms from the Nifty have clean accounting
November 22, 2013
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Strategy Myth 5: It takes too much time and effort to assess accounting quality on a stock-by-stock basis. We can give interested clients an accounting heatmap of their portfolio within five working days of receiving their portfolio if the constituent stocks are in our accounting model. A sample screenshot of what such a diagnostic looks like is presented below.
Exhibit 17: Indicative portfolio heatmap
Scores Ambit Companies sector ABC XYZ PPP DEF GHI RRR TTT PQR Industrials Utilities Utilities Metals Metals IT Oil & Gas Oil & Gas Cont Audit fee- Audit fee-% Non-oper CFO Change in Liab-% of % of stan of auditor's exps-% of EBITDA depr rate NW net revs remuneration total revs 11 13 1 12 10 3 6 7 12 8 5 10 6 2 11 13 13 12 8 4 7 10 5 3 8 9 10 5 6 12 4 2 2 5 8 6 1 7 4 3 13 12 8 3 2 10 7 1 PFD-% of Cum. Change in Cash debtors Overall FCF/medi reserves/(PAT yield more than Score an revs ex dividend) six months 6 2 11 3 12 8 1 4 13 7 11 6 5 10 1 1 11 7 6 13 12 5 10 2 3 3 3 3 3 3 2 3 8.5 7.3 7.4 7.1 6.6 6.7 5.3 4.3
ORANGE denotes underperformance relative to the sector average
For a more detailed analysis, we also do extensive company specific bespoke research for clients. A sample report has been attached in the next section.
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Strategy
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World Cargo
Sample Bespoke Analysis World Cargo
SAMPLE BESPOKE ANALYSIS
High hopes but poor accounts

Whilst the Real Estate and Metals background of the promoter couple may not provide relevant industry experience, they do provide them with capital and relationships. Using these advantages the promoters have built World Cargo into a force to be reckoned with in the logistics industry. Whilst primary data and peers highlight the long-term potential of the business being created by World Cargo through superstar employees, a marquee advisory board and the right regulatory reach, the companys accounts raise lots of questions.
Plenty of RED FLAGS

Revenue booking seems aggressive World Cargos industry leading debtor days rose at a much faster pace than its peers (Gateway, Allcargo and Concor) in FY10 whilst its revenues increased marginally by 4%. Despite the highest receivable days in the industry, provisions for doubtful debts remain very low at 0.3% compared to 2-20% for its peers. Concerns on revenue booking are accentuated by the appallingly low investment income return rates for FY09 (4.8%) and FY10 (1.4%) on cash holdings whilst peers have posted 3-5% investment returns on cash. Understated depreciation expenses boosting earnings? Significantly low depreciation rates vis--vis peers on buildings and the Rail License Fee appear to be inflating the net earnings of the company. Despite peers amortising the Rail License Fees on a straight line method over the 20 years of concession period, World Cargos choice of amortising it using management estimates of revenues and operational usage over 20 years appears to be aggressive (given that investments and operations may not pan out as expected by the management). Auditor certification for not even half of the income and balance sheet! World Cargo changed its auditors at the beginning of FY10 to ABC & Co. from Big4 as Big4 expressed its unwillingness to continue (source: BSE). Whilst we do not consider the accounts of other companies audited by ABC & Co. (Zee Group and Welspun) as topnotch, what worries us the most that neither Big4 nor ABC has audited ~50% of revenues and Balance Sheet for the last 2-3 years. Whilst international revenues dominance does explain the gap on account of audited revenues, we fail to understand that why the main auditor does not audit the nearly 10% of consolidated revenues and 30% of the consolidated assets of the Indian subsidiary World Cargo Rail Infrastructure (audited by LMN & Associates).
Snapshot
Section Accounting analysis Expense manipulation Cash manipulation Fictitious revenues booking Debtors provision Auditors Source: Ambit Capital research Notable findings RED FLAG in respect of CFO/EBITDA and debtor days RED FLAG in respect of depreciation RED FLAG in respect of unclassified loans and advances RED FLAG in respect of investment income returns RED FLAG RED FLAG
Analyst Details
Nitin Bhasin +91 22 3043 3241 nitinbhasin@ambitcapital.com
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Accounting analysis
Exhibit 1: Revenue Recognition
Company\Metric CFO as a % of EBITDA FY08 Gateway Distriparks (Gateway) Allcargo Global Logistics*(Allcargo) World Cargo Container Corporation of India (Concor) Average (A) 85% 88% 18% 78% 67% FY09 75% 37% 44% 86% 60% FY10 132% 86% 24% 65% 77% FY08 38 47 59 1 36 Debtor days FY09 38 41 83 2 41 FY10 46 47 143 2 60
Average (ex-Concor) (B) 64% 52% 81% 48 54 79 World Cargo divergence from peer group -49% -16% -53% 23 42 83 average (A) World Cargo divergence from peer group -45% -8% -57% 11 29 64 (excl Concor) average (B) Source: Company, Ambit Capital research, Note: (a)* Dec year end, year end for other companies is March; (b) We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies; (c)CFO/EBITDA for Allcargo is calculated after adjusting for the exceptional items of Rs-26.3mn and Rs5.6mn in CY08 and CY09, respectively and World Cargos EBITDA for FY08, FY09and FY10 is adjusted for the forex losses and loss on sale of asset included under other expenses
World Cargos CFO/EBITDA declined significantly in FY10 as CFO declined by 35% due to increased working capital investments while EBITDA increased 21% on a YOY basis. However, after detailed analysis of the CFO and EBITDA for World Cargo for FY09 and FY10, we find the following unexplained anomalies, which raise a RED FLAG: 1 In FY10, World Cargo reported Loss on foreign exchange fluctuations (net) of Rs31.3mn under Administrative and Other Expenses in its P&L while reporting a GAIN under Exchange Adjustments of Rs167.3mn in the cashflow statement, and In FY09, World Cargo reported Gains on foreign exchange fluctuations (net) of Rs37.7mn under Other Income in its P&L while reporting a LOSS under Exchange Adjustments of Rs161mn in the cashflow statement.
If the above amounts were to be adjusted from CFO and EBITDA (considering that such foreign exchange investments were on account of operations) then the CFO/EBITDA for FY09 and FY10 would be 18% and 52%, thus trending in line with its peers. Non-disclosure of the nature of these foreign exchange adjustments needs explanation by the company. World Cargos debtor days have always been ahead of its peers and have shot up significantly in FY10. Debtor days for Gateway and Allcargo have been considerably lower and more stable compared to World Cargo. Whilst World Cargos debtors increased nearly 100% on a YOY basis (Rs2.7bn in FY10 from Rs1.47bn in FY09), revenues grew by a nominal 4%. Part of the increase in debtors can be explained by a substantial increase in revenues from the rail freight business (FY10 revenues of Rs482 mn from Rs20 mn in FY09). But such a high jump in debtor days (when the industry has not witnessed such a trend) and a low and declining provision for doubtful debts (see exhibit 6) raise a RED FLAG.
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Exhibit 2: Depreciation rate comparison
Company\Metric FY08 Gateway Allcargo* World Cargo Concor 5.1% 5.6% 17.1% 5.0% Depreciation rate (%) FY09 5.4% 7.1% 8.7% 4.7% FY10 4.7% 6.7% 4.9% 4.8% YoY change in depreciation rate (bps) FY09 33 145 (838) (25) FY10 (69) (39) (376) 6
Average 8.2% 6.5% 5.3% (171) (120) World Cargo divergence 8.9% 2.2% -0.3% (666) (257) from peer group average Source: Company, Ambit Capital research , Note: (a)* Dec year end, year end for other companies is March.(b) We have used Annual report of CY07, CY08 and CY09 Allcargo and Annual report of FY08, FY09 and FY10 for other companies
The depreciation rate for World Cargo has sharply declined over FY08-10 because World Cargo has added nearly Rs2.3bn of gross block in its logistics business over last two years on the Rs301mn of gross block of its erstwhile technology business. Moreover, a high proportion of land in the gross block (FY10: 22%, FY09: 14%, FY08: NIL) and a significant decline in the software gross block (FY10:0.3%, FY09: 21%, FY08:71%) has led to a sharp decline in the depreciation rate. Freehold land accounts for 3% and 17% of the gross block of Allcargo and Gateway, respectively. Despite a lower proportion of land in gross block, Allcargos high depreciation rate is on account of high depreciation rates (9-13%) on Plant & Machineries, heavy equipment and furniture (which account for 42% of gross block). Whilst World Cargos FY10 depreciation rate is closer to the peer , we highlight that World Cargos depreciation policy should be read taking note of the following: 1 World Cargo depreciates Rail License fees after considering the matching concept of revenue, on a weighted of the agreement period, projected numbers of rakes to be utilized over the said period and annual usage period of the operational rakes since put to use. The Rail License agreement period is 20 years from the date of commencement of commercial operations in 2007. This depreciation policy is materially different to Gateways policy of amortising Rail License Fees on a straight line method over the life of the agreement i.e., 20 years. Effective Rail License Fee amortisation rate for World Cargo in FY10 was 0.8% as against 5% for Gateway. Underreporting of depreciation forms the basis of managements comment Our unique model has resulted in World Cargo Rail being the most profitable private container rail operator in India in FY10 annual report (see pg27). Depreciation rate on buildings (2% of FY10 gross block) for FY10 is 2.6%, which is lower than the 3.3% and 4% provided by Allcargo and Gateway, respectively. World Cargo provides depreciation on its logistics operations and related services tangible assets on a written down value (WDV) method whereas others depreciate it on a straight line method. However, adoption of WDV policy is not visible in the reported low depreciation charges. The depreciation rate for World Cargo would have been higher at 5.5% in FY10 had it not capitalized pre-operative depreciation of Rs12mn. Considering the above points, the companys reported depreciation charge seems low to us. RED FLAG
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Exhibit 3: Cash Manipulation?
Company\Metric Loans and adv to Unclassified loans and Loans and adv to related parties as a % adv as a % of net related parties as a % of total loans and assets of net assets advances FY08 Gateway Allcargo* World Cargo Concor 1.2% FY09 1.8% FY10 1.9% 19.3% 6.5% 2.1% FY08 3.1% 0.5% 6.9% 0.0% FY09 2.0% 11.8% 4.8% 0.0% FY10 1.0% 7.0% 6.6% 0.0% FY08 0.1% 0.1% 0.3% 0.0% FY09 0.1% 3.6% 0.2% 0.0% FY10 0.1% 1.6% 0.6% 0.0%
14.5% 23.2% 3.4% 2.7% 3.7% 2.3%
Average 5.5% 7.8% 7.4% 2.6% 4.7% 3.7% 0.1% 1.0% 0.6% World Cargo divergence -2.0% -4.0% -1.0% 4.3% 0.2% 3.0% 0.2% -0.7% 0.0% from peer group Source: Company, Ambit Capital research Note: (a)* Dec year end, year end for other companies is March.(b) We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies (c) Employees, directors, promoters, promoter group companies and associates form part of related parties (d) Loans and advances to related parties include receivables as well
Whilst World Cargos unclassified loans and advances as % of net assets are lower than its peer , the concerning fact is that the ratio nearly doubled in FY10 when the peer numbers either declined or remained stable. World Cargos ratio doubled as the unclassified loans rose by 94% to Rs434mn, whilst net assets and revenues grew by a nominal 12% and 4%, respectively. Such a sudden increase without adequate disclosure and a proportionate increase in revenues is concerning. RED FLAG World Cargos loans and advances to related parties mainly comprise of receivables from Enterprise owned or significantly influenced by Key Management Personnel or their relatives. Whilst revenues from these entities have declined by 31% YoY in FY10 to Rs371mn, the receivables from these entities increased by 178% to Rs39mn (31 receivable days on these revenues in FY10 as against 9 days in FY09). Revenues from these entities account for 7% of consolidated revenues but receivables from these entities account for just 1% of receivables.
Investment income as a % of cash and marketable investments FY08 FY09 8.1% 6.1% 4.8% 10.3% 7.3% -2.5% FY10 4.0% 14.9% 1.4% 7.8% 7.0% -5.6% 7.8% 6.1% 4.2% 9.8% 7.0% -2.8%
Exhibit 4: Fictitious Revenue Booking?

Company\Metric
Gateway Allcargo * World Cargo Concor Average World Cargo divergence from peer group
Source: Company, Ambit Capital research Notes: (a)* Dec year end, year end for other companies is March.(b) We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies. (c) Investment income comprises of interest income, dividend income, profit/loss on sale of (current and not strategic) investments (d) Investments comprise of marketable/current investments and exclude investments in associates.
Whilst high holdings of cash can be the reason for low level of investment income returns for World Cargo in FY09 (cash accounted for 100% of cash and marketable investments), the significant drop in investment return rate in FY10 despite cash levels rising raises a RED FLAG. Cash accounted for 99% of cash and marketable investments and grew by 10% in FY10 to Rs723mn. However, cash also accounts for 84% and 100% of cash and marketable investments for Gateway and Concor, respectively, and yet those firms post higher investments return rates. Whilst Concors cash holding is relatively very high (Rs16 bn), World Cargos cash holding (Rs688mn) is very close to Allcargos (Rs964mn) and Gateways (Rs775mn).
Page 19
Sample Bespoke Analysis World Cargo Hence prima facie there should not be much of a difference between the cash returns posted by the latter three. Concors high investment return rates can be explained by the interest income that the company may be booking on its loans to employees that does not form part of the cash and marketable investments and high cash holdings parked in high return fixed deposits. Allcargos high investment return in FY10 was on account of unexplained profit from sale of shares of Rs204mn (81% of the investment income) from untraceable and undisclosed shares in the balance sheet. Adjusting for all other investment incomes, Allcargo and Gateway posted 4% and 4.4% income on cash holdings as against 1.4% reported by World Cargo. Could it be the case that the company has under-reported investment income? Detailed analysis of World Cargos investment income return is more concerning as it shows that despite cash and marketable securities remaining nearly stable in FY10 (see exhibit 6), investment income has shown a sharp dip. Further analysis highlights that the interest income includes interest received on loans and advances and cash deposits. As highlighted in exhibit 4 loans and advances have doubled in FY10, which means that interest income should increase in FY10 compared to FY09, but there is a sharp decline in interest income of Rs31mn in FY10. This inconsistency supports our earlier ascribed RED FLAG on this front.
Exhibit 5: Interest and Dividend Income for World Cargo as % of Loans and Advances, Investments and Cash
Rs mn, unless otherwise stated Interest income on loans, deposits etc. Dividend on Investments in liquid mutual funds Total Interest and other income Loans and Advances Cash and Marketable Investments Total Loans +Investments+ Cash Other Income as % of loans, investment and cash (%) Source: Company, Ambit Capital research FY08 25 35 60 186 2,313 2,500 3.9% FY09 41 31 71 273 657 930 4.1% FY10 10 0.4 10 547 723 1,270 0.9%
Exhibit 6: Debtors Provisions

Company\Metric Provision for bad debts as % of Debtors FY08 Gateway Allcargo* World Cargo Concor Average World Cargo divergence from peer group 20.6% 0.4% 0.3% 6.4% 6.9% -6.6% FY09 17.4% 1.8% 0.7% 9.0% 7.2% -6.6% FY10 20.0% 1.7% 0.3% 12.0% 8.5% -8.2%
Source: Company, Ambit Capital research Note: (a)* Dec year end, year end for other companies is March.(b) We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies.
Despite World Cargo having the highest debtor days (see exhibit 2) amongst its peer set, World Cargo has maintained the lowest provisioning for its doubtful debtors. Given such a low number and given that it is early days for World Cargos logistics business, we assign a RED FLAG on this front.
Page 20

Exhibit 7: Contingent Liabilities for World Cargo
Particulars Disputed Income -tax demands Claims against the company not acknowledged as debts Guarantees issued by bank on behalf of the group Guarantees and counter guarantees given by the company Amount outstanding towards Letters of credit given to bank Custom duty on pending export obligation against import of capital goods Total Contingent Liabilities Source: Company, Ambit Capital research FY09 (Rsmn) 22 16 18 609 544 60 1,268 FY10 (Rsmn) 7 30 58 4,359 644 138 5,236 Contingent Liability as a % of Networth 0.40% 0.30% 0.30% 10.20% 9.10% 1.00% 21.20% Contingent Liability as a % of Networth 0.10% 0.40% 0.90% 65.10% 9.60% 2.10% 78.20%
Contingent liabilities as a % of networth has increased by 2.7X because the guarantees and counter guarantees given by the company have increased by 6.2X in FY10. These guarantees are given to the banks in respect of secured loan facilities granted to wholly owned subsidiaries of the company for Rs2.1bn in FY10 (Rs495mn in FY09); these numbers for guarantees and counter guarantees remain same as in the stand-alone accounts.
Auditors
World Cargo International changed its auditors in FY10 (Aug-09) from Big4 to ABC & Co., a firm engaged in business consultancy, tax regulation, advisory services, internal audit and risk consultancy. ABC & Co also audits the accounts of Zee Group and Welspun Corp (flagship company of Welspun Group) neither of whom are corporates whose accounts would be rated first rate by us. We assign a RED FLAG for World Cargos audit quality: 1. Big4s unwillingness to audit the accounts of World Cargo at the end of FY09; and 2. Continuing non-disclosure of the auditors auditing nearly 50% of revenues and now 58% of the groups assets. What is more concerning is the fact that nearly 29% of these assets are from an Indian subsidiary World Cargo Rail Infrastructure. Accounts of World Cargo Rail Infrastructure are audited by a Mumbai based firm, LMN & Co for the last two years.
Exhibit 8: Rising share of unaudited balance sheet by the main auditor
In mn, unless otherwise stated Consolidated (A) Amounts not audited by the main auditor (B) B as % of A Source: Company, Ambit Capital research FY08 4,012 2,018 50.3% Sales FY09 5,034 2,499 49.6% FY10 5,259 2,530 48.1% FY08 5,061 929 18.4% Assets FY09 7,291 3,364 46.1% FY10 12,431 7,182 57.8%
Page 21

Exhibit 9: Audit Fees comparison with peers
Company\Metric Gateway Allcargo * World Cargo Concor Average World Cargo divergence from peer group Audit fees as % of sales FY08 FY09 0.10% 0.07% 0.18% 0.11% 0.16% 0.17% 0.01% 0.01% 0.11% 0.09% 0.05% 0.08% FY10 0.06% 0.19% 0.18% 0.01% 0.11% 0.07%
Source: Company, Ambit Capital Research: Notes: (a)* Dec year end, year end for other companies is March.(b) We have used Annual report of CY07, CY08 and CY09 for Allcargo and Annual report of FY08, FY09 and FY10 for other companies. (c) Audit Fees includes - Statutory fees, Out of pocket expenses and other audit expenses
Whilst the audit fees as % of sales has marginally increased over the years for World Cargo, it is significantly higher compared to the Gateway and Concor on account of higher out of pocket expenses and other audit expenses. These expenses have doubled in FY10 compared to FY09. Hence we attach a RED FLAG.
Exhibit 10: Break-up of Audit fees of World Cargo International
Auditors' Remuneration Statutory audit Other Services Out of Pocket Expense Total Source: Company, Ambit Capital research FY09 (Rs mn) 7.9 0.6 0.1 8.7 FY10 (Rs mn) 7.0 1.6 1.0 9.5 % of total audit fees 91.3% 7.3% 1.4% 100.0% % of total audit fees 73.2% 16.4% 10.4% 100.0%
Page 22
Institutional Equities Team

Saurabh Mukherjea, CFA Research Analysts Aadesh Mehta Achint Bhagat Ankur Rudra, CFA Ashvin Shetty, CFA Bhargav Buddhadev Dayanand Mittal, CFA Gaurav Mehta, CFA Karan Khanna Krishnan ASV Nitin Bhasin Nitin Jain Pankaj Agarwal, CFA Pratik Singhania Parita Ashar Rakshit Ranjan, CFA Ravi Singh Ritika Mankar Mukherjee, CFA Ritu Modi Shariq Merchant Tanuj Mukhija, CFA Utsav Mehta Sales Name Deepak Sawhney Dharmen Shah Dipti Mehta Nityam Shah, CFA Parees Purohit, CFA Praveena Pattabiraman Sarojini Ramachandran Production Sajid Merchant Joel Pereira
E&C = Engineering & Construction
CEO, Institutional Equities
(022) 30433174
saurabhmukherjea@ambitcapital.com
Industry Sectors Banking & Financial Services Cement / Infrastructure Technology / Telecom / Media Automobile Power / Capital Goods Oil & Gas Strategy / Derivatives Research Strategy Banking & Financial Services E&C / Infrastructure / Cement Technology Banking & Financial Services Real Estate / Retail Metals & Mining Consumer / Real Estate Banking & Financial Services Economy / Strategy Automobile / Healthcare Consumer E&C / Infrastructure Telecom / Media
Desk-Phone E-mail (022) 30433239 (022) 30433178 (022) 30433211 (022) 30433285 (022) 30433252 (022) 30433202 (022) 30433255 (022) 30433251 (022) 30433205 (022) 30433241 (022) 30433291 (022) 30433206 (022) 30433264 (022) 30433223 (022) 30433201 (022) 30433181 (022) 30433175 (022) 30433292 (022) 30433246 (022) 30433203 (022) 30433209 aadeshmehta@ambitcapital.com achintbhagat@ambitcapital.com ankurrudra@ambitcapital.com ashvinshetty@ambitcapital.com bhargavbuddhadev@ambitcapital.com dayanandmittal@ambitcapital.com gauravmehta@ambitcapital.com karankhanna@ambitcapital.com vkrishnan@ambitcapital.com nitinbhasin@ambitcapital.com nitinjain@ambitcapital.com pankajagarwal@ambitcapital.com pratiksinghania@ambitcapital.com paritaashar@ambitcapital.com rakshitranjan@ambitcapital.com ravisingh@ambitcapital.com ritikamankar@ambitcapital.com ritumodi@ambitcapital.com shariqmerchant@ambitcapital.com tanujmukhija@ambitcapital.com utsavmehta@ambitcapital.com
Regions India / Asia India / Asia India / USA USA / Europe USA India / Asia UK
Desk-Phone E-mail (022) 30433295 (022) 30433289 (022) 30433053 (022) 30433259 (022) 30433169 (022) 30433268 +44 (0) 20 7614 8374 deepaksawhney@ambitcapital.com dharmenshah@ambitcapital.com diptimehta@ambitcapital.com nityamshah@ambitcapital.com pareespurohit@ambitcapital.com praveenapattabiraman@ambitcapital.com sarojini@panmure.com
Production Editor
(022) 30433247 (022) 30433284
sajidmerchant@ambitcapital.com joelpereira@ambitcapital.com
Page 23
Explanation of Investment Rating

Investment Rating Buy Sell Expected return (over 12-month period from date of initial rating) >5% <5%
Disclaimer
This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.
Additional information on recommended securities is available on request.

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Accounting Thematic - Ambit

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Strategy

Accounting quality drives alpha

Saurabh Mukherjea, CFA saurabhmukherjea@ambitcapital.com Tel: +91 99877 85848

Ambit Capital Pvt. Ltd.

Accounting quality drives alpha

Bucket A Bucket B Bucket C Bucket D

227 198 176 146

8.8% 7.7% 4.7% -2.5%

Source: Ambit Capital research, Bloomberg

10% 0% 100 -10% -20% -30% Accounting score 200 300

15% 10% 5% 0% 100 -5% -10% -15%

P&L misstatement checks

Balance sheet misstatement checks

Cash pilferage checks

Audit quality checks

Here is a brief description of the accounting ratios:

I - P&L misstatement checks

II - Balance sheet misstatement checks

November 22, 2013

Ambit Capital Pvt. Ltd.

III - Cash pilferage checks

IV - Audit quality checks

November 22, 2013

Ambit Capital Pvt. Ltd.

Accounting quality and investment returns

10% 5% 0% 100 -5% -10% -15%

November 22, 2013

Ambit Capital Pvt. Ltd.

10% 5% 0% -5% -10% -15% D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

Accounting score based deciles

227, 8.8% 198, 7.7% 176, 4.7%

Sector neutral accounting buckets

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Ambit Capital Pvt. Ltd.

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Ambit Capital Pvt. Ltd.

Share price performance

Accounting quality is better for larger caps on average

Avg accounting score 210.9 191.5 184.5 174.7

Avg share price performance 11.3% 10.9% 7.8% -5.6%

November 22, 2013

Ambit Capital Pvt. Ltd.

Accounting quality and investment returns

November 22, 2013

Ambit Capital Pvt. Ltd.

Average share price performance

while Textiles, Mining, Utilities, FMCG and E&C show deterioration

November 22, 2013

Ambit Capital Pvt. Ltd.

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Ambit Capital Pvt. Ltd.

Myths around accounting quality

Accounting quality has predictive power

80 60 40 20 0 50 150 Accounting score 250

20 0 50 100 150 200 Accounting score 250 300

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

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Ambit Capital Pvt. Ltd.

ORANGE denotes underperformance relative to the sector average

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Ambit Capital Pvt. Ltd.

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