#Factors #Evaluating #Company #Management
Most investors realize that it is important for a company to have a good management team. The problem is that evaluating management is difficult. Many aspects of work are intangible. Obviously, investors can’t always be sure of a company by looking at the financial statements alone. Spin-offs such as Enron, WorldCom, and ImClone have demonstrated the importance of focusing on the qualitative aspects of a company.
Key takeaways
- There is no magic formula for evaluating management, but there are factors you should pay attention to. In this article, we will talk about some of these signs.
- When evaluating a stock investment, understanding the quality and skill of a company’s management is key to estimating future success and profitability.
- However, looking at the stock price alone can give false signals. The fact is that many major companies, such as Enron and WorldCom, have had their stock prices skyrocket despite corrupt and incompetent management operating behind the scenes.
- Look at indirect metrics like how long managers have been there and what type of compensation they receive as well as factors like stock buybacks to see how well management is performing.
Investopedia/Allison Cincotta
Management function
Strong management is the backbone of any successful company. Employees are also very important, but it is management that ultimately makes the strategic decisions. You can think of management as the captain of a ship. Although managers do not usually drive the boat, they direct others to pay attention to all the factors that ensure a safe trip.
In theory, the management of a publicly traded company is responsible for creating value for shareholders. Therefore, management must have the business acumen to run the company for the benefit of the owners. Of course, it is unrealistic to think that management only thinks about shareholders. Managers are people too, and they, like everyone else, are looking for personal gain. Problems arise when the interests of managers differ from the interests of shareholders. The theory behind the tendency for this to happen is called agency theory. She says conflict will occur unless management compensation is somehow linked to shareholder interests. Don’t be naive if you think the board will always come to the shareholders’ rescue. Management must have an actual reason to be beneficial to shareholders.
Stock price is not always a reflection of good management
Some say that qualitative factors are meaningless because management’s true value will be reflected in the bottom line and stock price. There is some truth to this in the long term, but strong short-term performance does not guarantee good management. The best example of this is the fall of dot-com. For a while, everyone was talking about how new entrepreneurs were changing the rules of business. The stock price was considered a sure indicator of success. However, the market is behaving strangely in the short term. Strong stock performance alone does not mean you can assume management is of high quality.
Duration of tenure
One good indicator is how long the CEO and senior management have been serving the company. A great example of this is General Electric, whose former CEO, Jack Welch, worked at the company for nearly 20 years before retiring. He is heralded by many as one of the best managers of all time.
Warren Buffett also spoke about Berkshire Hathaway’s impressive record of retaining management. One of Buffett’s investment criteria is to look for strong, stable management that is committed to its companies for the long term.
Strategy and objectives
Ask yourself, what types of goals has management set for the company? Does the company have a mission statement? How brief is the mission statement? A good mission statement creates goals for management, employees, shareholders, and even partners. It’s a bad sign when companies tie their mission statement to the latest company buzzwords and jargon.
Insider buying and stock buybacks
If insiders are buying shares in their own companies, it’s usually because they know something ordinary investors don’t. Insiders who regularly buy shares show investors that managers are willing to put their money where their mouth is. The key here is to pay attention to how long management holds the shares. Flipping stocks to make a quick profit is one thing; Long-term investing is another.
The same can be said about stock buybacks. If you ask a company’s management about buybacks, they will likely tell you that buybacks are a logical use of company resources. After all, the goal of company management is to maximize return to shareholders. A buyback increases shareholder value if the company is undervalued.
compensation
High-level executives earn six or seven figures a year, and rightly so. Good management pays for itself over and over again by increasing shareholder value. But knowing what level of compensation is too high is a difficult thing to determine.
One thing to keep in mind is that management in different industries takes different amounts. For example, CEOs in the banking industry earn more than $20 million annually, while the CEO of a retail or food service company may only make $1 million. As a general rule, you want to make sure that CEOs in the same industries receive similar compensation.
You should be suspicious if a manager is making an obscene amount of money while the company is struggling. If a manager truly cared about long-term shareholders, would that manager pay himself exorbitant amounts of money during tough times? It all goes back to the agency problem. If a CEO is making millions of dollars when the company is on the verge of bankruptcy, what incentive should he have to do a good job?
You can’t talk about compensation without mentioning stock options. A few years ago, many praised options as the solution to ensuring management maximizes shareholder value. The theory sounds good but it doesn’t work very well in reality. It is true that options link compensation to performance, but not necessarily to the benefit of long-term investors. Many executives simply did whatever it took to drive up the stock price so they could leverage their options to make a quick profit. Investors then realized that the records had been falsified, so stock prices fell again while management absconded with millions. Also, stock options are not free, so the money has to come from somewhere, usually through dilution of existing shareholders’ shares.
As with stock ownership, look to see if management is using options as a way to get rich or if they are actually linked to increasing value over the long term. You can sometimes find this in the notes to financial statements.
If not, take a look at the EDGAR database for Form 14A. The 14A will list, among other factors, basic information about directors, their compensation (including option grants) and insider ownership.
Bottom line
There is no single model for evaluating a company’s management, but we hope that the issues we have discussed in this article will give you some ideas for analyzing the company.
Looking at financial results each quarter is important, but it doesn’t tell the whole story. Spend some time investigating the people filling those financial statements with numbers.
#Factors #Evaluating #Company #Management
