Management are the people who are running your investment. Their decisions affect you – bad decisions cost you money, good decisions will make you money. So it’s good to spend a bit of time into quickly assessing how good the people running your business really are. Now, for us it’s not crucial because in our approach we’re investing in companies that have a moat – they have protection for decades. So because of their business models they will be around no matter who is running it. So while bad management can hurt the company, by investing in companies which have these moats it means that even if an idiot is running it your company it will continue to thrive.
So first thing to look for in management is how they are compensated – how they get paid. In all of the annual reports there’s always a ‘Corporate Governance’ section and this section tells you how the managers of your company get paid. What we want to see here is a low base salary – this is just the amount of money they make as a base salary, it’s the guaranteed money they will make no matter what happens. If the management gets a high base salary it means that the management will get paid well no matter what they do, and this doesn’t give them any incentive to do well for the company, so we don’t want to see high base salaries. How do you know what a high base salary is? Compare it to other similar companies of similar size, because size is what matters here. Bigger companies will pay their management more, that’s just how the game works. So for comparison look for a similar company that is of similar size and see the differences in how their managers get paid.
What we want to see ideally is that they get paid in stock. We want to see them get paid in stock because then the amount they get paid will be dependent on the stock price, which means their interests are aligned with us shareholders. If they do bad things that hurts the stock price then they get paid less. If they do good things which improve the stock price then we win altogether.
Another way to assess your management is to listen to the conference calls. In the US companies will do this every quarter (every three months) – they outline the financial results and then have a Q&A session with investors. The way they talk and answer questions will allow you to gauge their personality. If they’re using lots of salesman techniques then we know they aren’t being genuine. We want genuine people running our company. Why? Because it will help make the company successful. Being honest about mistakes will mean they can fix them rather than continuing in their arrogance and hurting the company. Being transparent will give shareholders true insight into the company. Good personalities will be good for the company’s success. If they’re humble then they’ll listen to what their customers have to say and use that to improve their product.
We can also judge their decision-making. Remember that we’re only going to invest in companies that we know really well. So as a consumer you will be able to tell what decisions are good and what decisions are bad. For example, all people who are into clothing have noticed a massive shift towards sustainable clothing. So if your clothing company is putting a big emphasis on having sustainable clothing then that’s a good decision that you know will do well for the business, meaning the management knows what they’re doing.
Those are all the qualitative ways to assess management the main quantitative way to assess management history what is called return on investment capital. This is a ratio which essentially tells you how efficiently the company invests their money. If you have a low ROIC it means that your management is spending a lot of money on projects which aren’t really bearing much fruit, whereas if it’s very high then it means that they’re investing in good projects giving good returns. Why does this matter? Because the cash the company makes is your cash – as a shareholder you’re entitled to a small part of the money they earn. Management can use that money to either explore new projects or give it back to you. So if you’re watching as your management waste money on all these pointless projects, then you better cry because that’s your money.
One more big sign for a bad manager is acquisitions. If your company is buying lots of other companies all the time then that’s almost-always bad. Note that you have to factor in the size of these acquisitions – so if you’re a $100 billion company buying a $5 million company, then who cares. But if you’re a $50 billion company buying a $30 billion company – that’s a big purchase that can really make-or-break you. So, in general, when management is buying lots of other companies all the time and they’re decent sized ones in comparison to the company they’re running – this is almost always a red flag. They’ll try and persuade you that it’s for the best with buzz words like ‘synergies’ and ‘accretive’. But if they continuously buying other companies there’s no justifiable reason for that, and it usually means that the manager is greedy and just wants to be the biggest company in that industry to fulfil their own desire. But don’t be turned off by all acquisitions as some do make sense, but as a general rule if it’s repeated acquisitions and they’re decent sized ones, it’s a bad sign.
So remember we are investing in companies that are protected forever so even if you do have an idiot running them then the company will continue to thrive. But if you’re interested in knowing who’s running your company and who’s in charge of your money, these are the ways to assess that