The quality of the management of a company has been proven not only to be one of the two critical factors in stock selection but the ultimate determinant to a profitable and rewarding stock investment.
For obvious reasons, an outstanding management can spell the difference between an excellent and mediocre business. An incompetent management can, on the other hand, can also drag a great business to the ground.
Above all, the market performance of a stock is determined by the kind of people running the company. A management that unfortunately treats the business as if they own the company rather than as hired hands that truly work for the interest of stockholders, do poorly in the market, in the end.
For some reason, most investors fail to take heed of this important advice before buying a company’s stock. Many cite herd mentality as the most common reason behind this behavior of investors. To most retail investors, the near-impossibility of meeting these people in management personally is cited as a big deterring factor.
Whatever the reason is, the need to knowing the people in the executive suite, so to speak, cannot be overemphasized. Armed with none or with small knowledge of this little detail has, more often than not, led to disappointing results.
Red flags
There are many ways to getting information about the personal background and professional track record of people managing a firm, especially the publicly listed ones. Talking to them certainly does not give you a guarantee of knowing a company intimately. Instead, you may find out more about them through newspaper and industry reports.
One old hand in the market, the indefatigable investor-businessman Oliverio “Olie” Laperal, is one person I know who has won most of his stock investing activities by giving more weight on his assessment of a company’s management.
Like what most references say on the subject, he seems to divide the management-assessment process into three parts: Compensation, character and operations.
The compensation plan of a management can be a revelation. This is found in the company’s financial reports.
In the required section of an annual report, you will find some details of how much officials are paid and what perks they receive. In other words, this section will teach you how management pays itself.
Big bonuses based on performance results may not be that alarming. But fat base salaries and generous stock options, especially those without restrictions, are red flags indicative of a management that could only be working for itself.
On second thought, big bonuses should not only be reasonable, but must be verifiably related to performance. Also, the perks given must be part of a scheme to enhance management ability to deliver desired corporate results rather than just for personal aggrandizement.
Next is character. There is a strong relationship between people on top of the company that are in only for the money and the people that treat stockholders’ interest poorly. Search for indications in the submitted reports if the officials use their positions to enrich friends, relatives, family members or former managers. Also, know if management is honest enough to own mistakes. A management that does not discuss poor decisions and why they were made is an indication of deficient character.
Also an essential part of character determination is whether management is able to acquire and retain high quality talent. A high turnover of personnel, especially at the managerial level, is “an ultimate acid test of the working environment and employees’ views of a company’s potential.”
Last is about operation. Determine if management can really run the company’s business well.
This can be revealed through a closer review of financial statements. References state that you will discover this by looking at the progress and, more importantly, the nature of the company’s return on equity (ROE) and return on asset (ROA) performances.
Check whether increasing ROEs and ROAs were driven by higher leverage, instead of improved profitability or asset efficiency. A good record based on higher leverage is not indicative of management’s skill and ability to run the business well.
Bottom line spin
The above is just the tip of the iceberg in guiding you to get a grasp of the quality of a company’s management. For sure, officials who do not at all disclose enough information about the foregoing considerations are the companies whose stocks you must avoid or should not invest in.