Understanding Conflict Of Interest
Many times, investors tend to underestimate the challenges of conflict of interests between the management and the investors.
When you come across a company that is very profitable and has a business model that is very unique, but you saw that the company has a huge portion of revenue coming from related party transaction and management seems to be overpaying themselves, what do you do?
Investment is about buying a piece of a business and entrusting that investment to the management, in hope that they will utilized it honestly and properly. Thus if that trust is not established, how can we possibly ensure that the investment is put to good use?
The Tales Of Two Counters
For this example, we look at two companies in the same industry; High-5 Conglomerate Bhd and QAF Limited (SGX:Q01). High-5 Conglomerate Bhd, previously known as Silver Bird Group Bhd is in the frozen and fresh bakery goods industry. It manufactures and distributes the “High-5” brand bread in Malaysia. The company is in similar business with QAF Limited, which distributes the “Gardenia” brand bread in the region as well. However, High-5 had been pledged with issues with the management and its accounting. A perfectly profitable and sustainable business fell into a company that has lost all its reputation. The share price of the company lost roughly 95% of its value.
Source: Bloomberg – Chart of High-5 Conglomerate Bhd
Now if we look at QAF Limited, the company is operating in the same industry, in the same region albeit it has other operations as well. Yet, we see a company where the share price roughly doubled in the past 5 years. QAF Limited has never reported anything major with regards to conflict of interests issue with its management.
Source: Bloomberg – Chart of QAF Limited
Value In Action
Sometimes, even when we know the business is profitable and has the ability to scale up in the near future, we should always do a final check on the integrity of the management and the trust we can put on them as investors.
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