Why should you stay away from dishonest management?

Everyone knows that logically, if management is dishonest, you should not invest. Warren Buffett also says this; he doesn’t want to deal with bad people, no matter how good or promising the company looks. If management is dishonest, then a veto is necessary, unless the company’s products are good or bad but have nothing to do with management—then it’s a different story, but such cases are very extreme.

For example, Moutai is like this: even if its management is dishonest, its products can still sell well and very well. So, in this regard, the influence of Moutai’s management on the company isn’t particularly large. Some chairmen retire and get arrested; some are arrested during their term. These arrests may have other reasons and do not necessarily mean dishonesty. Maybe there are other non-business reasons, such as corruption or embezzlement.

What I mean here is that there are issues with financial statements; public information, which does not involve personal matters. For example, marrying a “mistress” outside, etc. For instance, the chairman of “Buchang Pharmaceuticals” bribed to send his daughter to Stanford University. These are personal issues unrelated to stocks, although they also involve dishonesty, but they haven’t yet involved corporate dishonesty.

The dishonesty I refer to here has a different meaning. For example, a company that previously committed fraud, was punished by the CSRC, or was investigated, etc. The fines may not be large, but such companies should be vetoed outright. Just check their history—see if they have a criminal record.

The criminal record mentioned here refers to whether they have been fined. If yes, then the management hasn’t changed, and you should keep your distance. Dishonesty is a habit; once formed, it’s hard to change, especially in China, where the CSRC catches such fraudulent companies. The fines are usually small, but the chance of repeating the mistake is higher. These people don’t care much about reputation; they care about profit. If the cost of crime is low, they will reoffend.

This is a very obvious principle. On the surface, it seems simple: stay away from dishonest management. But in some cases, people’s minds become muddled. For example, recently, pharmaceutical stocks performed well, and many stocks rose. Some think these companies are too expensive, so they start buying so-called undervalued stocks.

These stocks have limited gains, and their P/E ratios are relatively low. But often, some companies may have accounting fraud or dishonest records. For example, Buchang Pharmaceuticals had some issues a few years ago. The financial reports looked good, with strong revenue growth. But in reality, their revenue wasn’t that good; there were many hidden accounts receivable not reflected. They once colluded with a pharmaceutical company, but this fraud was eventually exposed, causing the stock to plummet.

Therefore, for companies with a history of criminal records, we should avoid them as much as possible. Maybe some companies are innocent or have only made one mistake and have since corrected themselves, but you still shouldn’t take risks. You can’t bet on a bad person—an offender might reform, but that’s a low-probability event. So, we shouldn’t gamble on a prodigal son returning because the risk is too high. From an investment perspective, once there are false financial reports or similar behaviors, it adds a lot of uncertainty and risk.

You can’t judge whether their published reports are truthful. Although the stock price may seem undervalued based on the reports, whether these financial data are real, whether profits are correct, gross profit margin, return on equity, etc., all contain traps. These are judgments based on financial statements. If management is dishonest, their reports can’t be trusted. If someone is a liar, then what they say isn’t trustworthy.

Therefore, this kind of risk and uncertainty cannot be quantified; you can’t determine whether management is telling the truth or lying, so you can’t do a quantitative assessment. Stay far away from such companies—the farther, the better. Good companies have a high degree of certainty; they are very rare, but they do exist. There’s no need to wade into muddy waters or involve questionable companies. The stock prices of such companies are relatively low, with low P/E ratios, seeming undervalued.

But insiders can see that the management is dishonest and likely cooking the books. These undervalued figures are probably based on false calculations, making the conclusions unreliable. Many retail investors, wanting to buy cheap stocks, don’t realize that the underlying earnings data are highly questionable and inflated. The stock price looks low but might actually be higher than similar high-priced stocks! As retail investors, we need to understand what kind of person we are—don’t wade into muddy waters. It’s a high-difficulty move, best avoided.

The difficulty of investing is roughly unrelated to making money in the crypto or stock markets. Investing isn’t a diving competition; increasing difficulty scores isn’t the goal. It’s not like the college entrance exam where solving all problems yields a higher score. Investing is about certainty—choosing simple companies you can understand, with management you trust, not guessing whether they will reform or commit fraud. All these involve a lot of uncertainty.

If you buy such cheap stocks, you must be extremely careful! Just like many people love shopping at “Panjiayuan” Taobao—most of what they buy isn’t as good as what they sell! So, you need to know your own position and ability. If you’re in an environment like “Panjiayuan,” where fake goods are common, especially among frequent sellers of fakes, expecting to buy genuine products there is laughable. Your greed and desire for cheapness drive you to do this.

A so-called undervalued stock, when analyzing from financial statements, if you find that the company’s management has a history of fraud, there’s no need to look at the financials at all—just veto it outright. Once you find a history of fraud, it’s best to stay away. Such financial statements lose their valuation basis and lack credibility; evaluation becomes impossible. There’s no such thing as undervalued or overvalued in this case.

Such stocks might rise and make investors a lot of money, but that isn’t for you. We only earn what we understand, only certain profits, and we shouldn’t gamble on management. Bad management might improve, but that’s uncertain. The most important thing is that buying stocks of poorly managed companies can cause psychological issues—lack of confidence means that if the stock price drops, you can’t hold on. As a value investor, the more the stock drops, the more we buy because risk is being released.

If we’ve done thorough research on the company, we should operate inversely—buy more as the price drops. When the stock price falls further, we buy more shares at a lower cost, and when it rises later, we profit more. As the stock price drops, the number of shares we hold increases. Buying at 10 yuan or 2 yuan with the same capital results in different quantities.

Lower stock prices allow you to buy more shares, creating a larger gap for profit. These two factors together can bring substantial returns. But the problem is, if you’re investing in a company with questionable management, it’s very risky. In such cases, you can’t tell whether the sharp decline increases risk or releases risk.

You don’t know if the plunge is due to market panic or fundamental problems with the company. Opaque management, dishonest practices, hidden issues, even fraud—these can all be reasons. So, you can’t make a correct judgment. Under such circumstances, you dare not operate inversely and buy, or even holding the stock becomes problematic.

Once you hear bad news, you’ll panic and become afraid. The time cost is high—once you hold stocks, and the price starts to fall or rise slightly, you rush to sell. Buying such stocks results in only two possibilities: one, it’s truly a good company, but when it falls, you’re afraid to buy, ending up with a small position; or two, it rises slightly, and you sell, missing out on gains. Having a low position is also missing out.

This also affects your returns. Missing out is one of the main risks in crypto and stock markets. Another worse risk is losing your principal. If you buy a junk company and it suddenly collapses, the stock price might keep falling. Like what happened with companies like Kangmei Pharmaceutical, the stock could go to zero. Ultimately, you might suffer permanent loss of principal.

Therefore, buying stocks of such companies, if the stock price rises, you’ll miss out; if it falls, you might lose your principal permanently. Buying stocks of companies with questionable management is very dangerous—you won’t be able to hold the stock steadily or make significant profits. Instead, you’re more likely to lose money. That’s why I say to stay away from these dishonest management companies. The psychological logic behind this is clear.

Moreover, even if you make money buying such stocks, it’s very tiring. Because management is poor, you are aware that they may have made mistakes before or have bad records. Dealing with such companies is like dealing with a liar—you know they’ve lied before, and being with them is exhausting. You don’t know which of their words are true or false.

Any small change or rumor requires you to analyze the company and the news. Such companies often have continuous negative news. Even if you buy at a low price, you have to guard against management like guarding against theft—always alert, anxious, and worried. Even if you make money, your quality of life suffers, which isn’t worth it.

Making money is to improve life quality— isn’t that the main goal? Usually, you lose money and sacrifice life quality, making it even less worthwhile. So, stay away from dishonest management companies because, in most cases, you’ll step on a landmine. Don’t go into the minefield. To avoid wet feet, don’t go near the riverbank.

Good companies are clearly laid out there—why not invest in them? Actually, investing in just a few companies is enough. The world’s super-rich rely on investing in just a few companies, or even becoming rich from one company. Why invest in questionable companies just because they look cheap on the surface? They might not be cheap at all—they could be just a stone sold at half the price of jade. Do you think it’s cheap?

That’s why I keep reminding everyone: don’t just look at the stock price. You need to look behind the company. A seemingly low-priced, small-cap stock trading at 1 or 2 yuan might be more expensive than a high-quality company trading at 2000 yuan. So, don’t just blindly chase low P/E ratios; examine how that ratio was calculated, who prepared the financial statements, and whether the person doing the reports is reliable. That’s the real question to investigate.

The P/E ratio is just a number—very simple, computable by any machine. If you rely solely on this for investing, anyone can make money. Then what’s the point of people? Machines can do it and make money. You must dig into the reasons behind the company—avoid doing things that shouldn’t be done. Life is like investing; choosing correctly is crucial. Choose the right company, the right people, the right marriage. Don’t expect to change a scumbag after marriage—that’s inefficient.

Stocks are the same. Don’t buy companies with bad management, don’t expect them to get better. That’s just your hope and human nature. But that doesn’t reflect reality because you can’t change others, can’t change management, and can’t change the company. The only thing you can do is change yourself—make the right choices. Don’t do things just because they’re cheap—that’s human nature.

Seventy percent of investing is human nature. Don’t you understand how to judge a company? Don’t you know what a good company is? I believe most people know what a good company is. Why do they buy bad companies? Because they want to get rich overnight, thinking that if the stock is 1 yuan now and rises to 10 yuan, they can multiply tenfold. But if it’s a problematic company, even at 1 yuan, it might eventually fall to a penny or delist.

So, analyze a company rationally, not with animalistic greed. Trying to get rich overnight in crypto or stock markets will definitely lose money. That’s why most investors lose money. Want quick gains, seek cheap stocks. Think many quality companies’ stocks are very high, so they start buying some low-priced companies.

I’m not saying to chase high and buy those quality companies at high prices. Quality companies require patience—waiting patiently might take 5 or even 10 years, but then the certainty is higher. Therefore, investing in crypto and stocks requires patience. When choosing companies, prioritize quality companies and avoid buying poor-quality stocks. Also, wait patiently for the right investment opportunity.