Like many investors, we try to gauge the quality of management of the companies we invest in. We believe that the prevailing investment concern should generally be the quality of the business rather than the people running it, but poor management can quickly erode value, even in a good business, so it’s important to have confidence in the people pulling the levers.
Confidence and charisma only part of the story
This is not always easy to do. As investors, you tend to see only a carefully curated slice of the senior executives, and it’s easy to be impressed by charismatic leaders or confident presenters, but confidence and charisma may not be what’s required for ultimate success. To make a reliable assessment of management may take years of carefully following commentary and promises, and comparing these against subsequent achievements.
(As an aside, it is interesting to note that CEOs the world over tend to conform to certain stereotypes. For example the average CEO is much taller than the population average. Not many boards would explicitly set height as a CEO requirement, but it clearly finds its way into the selection process).
Where a detailed multi-year track record of success in the role is not readily available, there are some things you can focus on as an investor to get a read on management. The key is in having a clear idea of what skills or traits really matter, and which you can sensibly assess from outside the company.
Characteristics to look for
Here are some things on our management shopping list, together with the reasons why we think they are important, and some indicators you can look at to help judge whether they are present.
At the top of the list is integrity and character. Ultimately, management is in control, and a CEO who puts their own interests ahead of shareholders is unlikely to do a good job for investors. This problem is sometimes referred to as agency risk, and there are many ways your ‘agent’ can act contrary to your best interests. These include using investor funds to build an empire through unsound acquisitions, and managing the business or the share price (such as through buy backs and unsustainable dividend policies) to achieve their personal remuneration goals rather than to maximise the value of the business.
Also look at the standard of disclosure. Is the business and its performance explained by management in a clear and transparent way, or is it largely PR spin and obfuscation that makes it difficult to understand what is really happening (recall Enron)? Good management will demonstrate respect for the owners by telling the market what is happening, and letting investors set the share price accordingly. Management that is more concerned with managing the share price than the business is unlikely to do well at either in the long run.
The remuneration report can also tell you something about agency risk. Modest rates of remuneration and a focus on long-term performance goals can be taken as a very good sign, especially if profitability measures such as return on equity are considered.
Another useful management attribute is passion for the business. A good leader need not be perpetually cheerful, but one who genuinely enjoys the work they do will achieve far more than one who doesn’t. When you hear a passionate manager speaking about their business, their enthusiasm is usually apparent. Paul Zahra at DJs may be well-regarded by some of the larger shareholders, but from reading recent reports it might be reasonable to assume that he’s not tap-dancing to work. A manager who doesn’t enjoy what they are doing may find it challenging to give their best efforts for the company, or to inspire others to do so.
Must understand the specific industry
On a related note, we believe that a detailed understanding of the business by the executive is valuable. A manager that has a complete grasp of every aspect of their business and its industry can be far more effective than one who relies heavily on others to fill in the gaps. Every negotiation or interaction with suppliers, customers and staff presents an opportunity for a poorly-informed manager to put a foot wrong by failing to properly understand the flow-on effects of the choices they make.
There is no substitute for industry experience, so it’s good to look at senior management CVs. A CEO who can confidently answer questions on the business without needing to delegate them, take them on notice or issue subsequent ‘clarifications’ is usually a good sign.
This is a far from exhaustive list, and other skills including intellect, vision and strong leadership will be more or less important depending on the business and the circumstances. However, as a general observation, if you can feel comfortable that management is honest, enthusiastic and knowledgeable (in that order), you have a reasonable basis to expect that they will be able to steer the ship around some of the larger icebergs that inevitably lie in the path of every business venture.
Roger Montgomery is the founder and Chief Investment Officer at The Montgomery Fund, and author of the bestseller ‘Value.able‘.