4 Tips in Assessing Company’s Management
In his annual letters, Warren Buffett talks about the three criteria that he looks for when investing in the stock market. He likes companies that he understands, has an able and honest management and a reasonable offer price.
If we were to follow this advice, the first criteria on buying only companies he understands and offered at a reasonable price is an easy task. For instance, you would like to buy Coca-Cola stock if it goes down to more attractive levels, than some up and coming biotech company whose stock price have already reached new highs.
A more complex task is to assess management. It can’t be quantified with some financial ratios or some algorithm. Although there are some investors who prefer to look at the hard numbers and earn excessive returns, management is important element in generating satisfactory returns.
The main reason is that management drives the company’s strategy which in drives the company’s profits and stock valuations. Having a good management in place creates a big margin of safety for value investors.
Our problem is how to objectively evaluate management’s performance. Is it a multi-year astronomical earnings growth? Is it a higher than expected dividend payouts? It could be. But here are some of the tips that might be useful in evaluating management.
1. Management has substantial stake in the company:
Good management has substantial ownership in the company. He believes that there’s no other better alternative for his money than placing it in the company. This provides a sense of security for investors knowing that management won’t do something foolish in the long run as they have their wealth invested in the company.
Warren Buffett is a good example of this. Majority of his net worth is tied up to Berkshire Hathaway. He literally eats his own cooking. He does not guarantee yearly superb performance, but he assures investors that their fortunes are directly correlated to his net worth.
2. Management is candid in admitting their mistakes:
If you happen to ask a CEO of a publicly listed company, he would often give you rosy picture of the company. When bad things happen like an earnings disappointment, they usually have an excuse for the poor performance. They blame the government and economy for their misjudgments.
What you want in a CEO is someone who is not afraid to admit that they have made mistakes. In fact, Warren Buffett would often ask for apologies for mistakes of commission and omission. When he invested in an industry that has poor economic prospects, he was quick to admit it. He also guarantees that there will be more mistakes in the future.
3. Management who thinks and invest like an owner:
You should only look for management who thinks as a fiduciary of your money. You don’t want someone who increases their bonuses at the expenses of the shareholders. You want someone who can invests in projects and activities that creates value for the shareholders in the long run.
A good lesson from the recent financial crisis is that CEOs of the top-tiered banks have fat bonuses. In other words, they were rewarded for bringing in these toxic assets and wiping out the capital of the bank. This is an exact opposite of Warren Buffett. His $100,000 a year salary can be compared to a junior investment banker straight from school. Despite a meager salary, he outperformed the market for the last 50 years. His secret is that he thinks and invests like a real business owner.
4. Management is consistent in their plans and results:
If you read the section on Management’s discussion and analysis over the last couple of annual reports, you will be amazed that majority of the plans of management were not implemented. They often promise that they would give you tremendous increase in net profit from cost effective measures. More likely, they have not been religious with that plan. You want a management who is consistent with their words and actions. In short, you prefer an action man rather than a mere strategist.
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