Context
Fundamental analysis of companies involves studying the management of the company. Some indicators of good management are (a) Good pedigree (educational qualifications), (b) Experience in the industry domain, (c) Walking the talk (doing what they say). No matter how much you research a company’s management, there are some cases where you would be surprised by sudden ousting of the management. Example – Chanda Kochhar, the first female MD and CEO of the second biggest private bank in India, ICICI. Chanda Kochhar has been recognized globally as one of the most influential business persons by Forbes, Times etc. However, the 2018 allegations of cheating and defrauding against her led to her employment at ICICI being terminated. The aftermath on ICICI bank- stock price slipped by 11% after the news surfaced. For the next 1 year ICICI bank stock underperformed other private bank stocks such as HDFC bank.
How can existing retail investors act in such situations, where the senior management of a company gets ousted? Should new investors see the stock price dip in these situations as a buying opportunity? I will try to answer these questions, and more in this article.
Distinguish between Ousting and Retirement
The first step is to recognize the situation itself. This can be done by understanding the difference between natural retirement of the senior management, and ousting of the management. This part is important, because the company tries its best to subdue the ousting the management. Often, ousting news is spun with a positive ring to the news.
Natural Retirement
Senior management can retire from their post in a company because of natural reasons, poor health, high age etc. Example: Retirement of Aditya Puri, one of the most successful CEOs of HDFC bank in 2020. Usually, news of planned senior management retirement is made in advance, sometimes 4-6 months in advance. The company explains the reasons for retirement, and indicates the transition period with the newly appointed or interim CXO.
Stock Market Reaction? Stock markets may react positively or negatively to the natural retirement of senior management. Some investors may take the retirement of a successful, long term serving CXO of a company as a short term uncertainty in the company’s capability to implement its strategy. More often than not, the stock price of the company in the short term moves sideways or dips slightly on such news.
Ousting of Management
Senior management can be ousted on the basis of poor performance, fraud allegations, differences with the promoters of the company etc. Some key indicators of ousting of senior management are:
- Covering up the news: The company will try to make the news sound positive. Example: ‘Our CXO has decided to pursue his/her other personal interests.’. Or ‘We have hired a new CXO to drive strategy 2.0’ etc.
- Overnight News: The news of ousting of the management comes as a surprise, with no prior notice.
- Leading news of fraud against the management: Ongoing news of allegations of fraud against the management is often a leading indicator to ousting of that senior manager.
- Terminating all connections with the company: The ousted management is made to sever all ties with the company immediately. In natural retirement cases, the senior management typically remains on the advisory board of the company for some time, and helps with the transition process for several months. However, in case of ousting, it is blunt termination from all services whatsoever with the company.
- Accompanied by other senior resignations: Apart from the CXO, other senior members of the company also resign or are terminated. This happens as the senior officials close to the CXO, loyal to him, are considered to have the same working style as the ousted CXO. They are asked to leave along with the ousted CXO. This indicates a management clean-up happening in the company.
Example 1: MD & CEO of Ujjivan Small Finance Bank – Mr Nitin Chugh, resigned abruptly in Aug 2021. This was accompanied with other senior officials leaving the company. A news articles on this mentioned the company’s parent company being unhappy with Mr Nitin regarding the company’s performance, and handling of the bank’s asset quality. [Link]
Example 2: Solara Active Pharmaceuticals CEO, Mr Bharat Sesha resigned soon after weak Q3’22 earnings were reported. Subsequently, the company announced a change in strategy to move from a distribution led sales model to direct-to-consumer sales model. This is a positive spin to the termination of the CEO.
Stock Market Reaction? Stock price of the company usually tanks after the news of senior management ousting. Ujjivan Small Finance bank stock price tanked by 50% after the news. Solara Active Pharmaceuticals stock price tanked by 31%.
Now, you have a fair idea on how to identify the situation of ousting of senior management. Next, let us see how existing and new investors should act post such news.
What should retail investors do?
A quick summary of what investors should do is in the table below:
| Type of Company | Recommended Action | Example |
| Fundamentally Good Company, with consistent returns in the past. Company has moat, or is a market leader | Conservative Investor – Hold; Aggressive Investor – Buy | ICICI Bank: price dipped after Chanda Kochhar’s termination in 2018, but in the long run ICICI bank stock did well between 2019-2022 w.r.t Bank Nifty Index. |
| Inconsistent performing stock, no or weak moat, not a market leader | Sell 100% of stock | Ujjivan Small Finance Bank – price dipped by 50% after ousting news |
The recommended action for an investor depends on the type of the company.
Is the Company Fundamentally Strong?
If the company is a fundamentally strong, then a conservative investor should hold his investments in the stock. An aggressive investor can buy the dip in order to make gains in the long run. Fundamentally good stocks are companies who have shown consistent performance in the past five years in terms of growth in revenue, net profit, consistent or growing Profit Margin and Return on Equity. Fundamentally good companies either have a moat, or have a large market share in their business segment.
For a conservative investor, it makes sense to hold the stock and NOT sell it once the news comes out of management ousting. There will be short term pain in the next 2-3 months. However, in the long run, the company with strong fundamentals will bounce back and deliver decent (at least index average) returns.
For an aggressive investor, the price dip owing to the ousting news can be seen as an opportunity to buy the dip at fair / attractive valuations.
If the company is NOT fundamentally strong – indicated by inconsistent growth in revenue, profit margin and return on equity – then existing investors should exit the stock by selling all of their shares.
What If questions…?
Q1: What if the stock contributes to a large part of my stock portfolio, say > 30%?
A1: Well, having one stock contribute to more than 10% of your overall stock portfolio is not a wise thing. My view is to still sell the stock if it is not a fundamentally good company, and hold it if it is. Consider the loss from selling the stock as a tuition fee to Mr Market, for the valuable lessons taught by the market to you.
Q2: What if the company is headed for a turnaround with the new management and modern strategy?
A2: This might happen – in one out of ten instances of management ousting cases. Are you willing to take the risk of the low chance of a turnaround? I would not, and I would not recommend someone else to do so as well.
Q3: Isn’t cleaning up of poor performing management, replacing them with more efficient management, a good sign?
A3: Not necessarily. Let’s assume that the new management is better, more efficient than the old management being ousted. It takes time for a new management to show turnover in a company, sometimes even multiple years. The right question in this case an investor needs to ask is – are they willing to suffer pain for 1-2 years, before seeing a probable uptick in price, or will they prefer selling the stock and invest their money in other good opportunities (stocks) in the market. I would rather do the latter. I also want to highlight that in no way am I saying that 1-2 year of holding a stock is not the right thing to do for the “intelligent investor”. Rather, that the investment decision should be factual, and not hopeful.
Q4. Can we predict management ousting in advance, and face the losses post the news surfaces?
A4: Not really. It is difficult to predict the ousting of a senior management. These decisions are secretly made, and often executed overnight. Even the company employees are not made aware of these decisions in advance. However, there are some indicators which can lead to ousting of the senior management that retail investors can look out for as potential early red flags:
(a) Consistent Poor earnings performance of the company over two or more consequent quarters. This performance is deviant from the projections made by the management earlier.
(b) Inability to deliver the company strategy: Falling behind on execution timelines. Inability to crack business deals to keep the company’s order books healthy.
In case a and b, the promoters or majority shareholders of the company such as Private Equity companies, can take the decision to fire the senior management, holding them responsible for poor performance of the company.
Do note that poor performance of the company should not be viewed in isolation, rather in relation to the performance of the overall industry segment. If the overall industry segment is doing poorly, then the company in question is also expected to post poor performance – and this has nothing to do with management’s capability. Example: Due to supply side constraints arising from strained logistics and rising cost of raw materials, the entire specialty chemicals business in India performed poorly in Q2’22 and Q3’22.(c) Fraud allegations against the management/their family members: News of fraud allegations against the senior management is an indicator that the management will either resign to save face, or will be terminated in order to prevent the bad influence/image from the news being reflected on the company. Fraud allegations question the integrity of the person, and the company which that person is leading.
Parting Thoughts
Hope this helped to understand how to perceive the situation when a company’s management is ousted. Each such situation warrants a relook at the company fundamentals and future growth strategy. Not all management ousting is a bad sign. The basic investment principles remain the same – pick fundamentally strong company available at a discounted price.
Did your invested company had a management ousting? What did you do? Do share in comments below.
