Most folks will know the importance of a good management team in a company. Good management can lead a company to higher revenue, profit and growth. Poor management can bring a company down, sometimes toward bankruptcy, destroying shareholder value in the process. Hence, part of the stock investment process will require some form of assessing and evaluating the management of the company you are looking at.
The problem is that evaluating management is difficult – so many aspects of the job are intangible. This part of the analysis is always more qualitative rather than quantitative.Back in my university days, I had studied case studies like Enron and Worldcom to know that management might not always have the shareholders’ best interests at heart. I am not here to show you guys some sort of magic formula to evaluate management but there are things an investor can pay attention to and these things usually offer some tell tale signs. Here are 4 things to look out for:
1.Credible or reputable names sitting on the board or C-level management
The information of the management team and the board of directors is readily available and found in the annual reports or you can rely on websites like Morningstar, Bloomberg, 4-Trader. After looking at the list, I will always like to do a google on the names of the CEOs, CFOs, the other C-level executives and board of directors of the company to see if i can find any information on them. In other words, I am doing fact finding and background checks. Closer to home, when I look at SGX companies if I get to see reputable or famous names with a track record sitting on the board or as key executives, this will give me a boost of confidence in the management.
2. Ownership and Insider Trading
A shareholding stake in the company signifies the commitment of the management in the company. The larger the stake, the bigger the commitment. When management has a significant stake in the company, their financial rewards are tied closely to the company’s performance. They are more likely to work harder for the company and ensure that the business is successful and profitable.
Without a stake in the company, management is more likely to make decisions based on personal interests rather than for the company as a whole. Where can I find information on ownership? Ownership information can be found in the annual report typically under the corporate governance segment or shareholding statistics.
If insiders like the CEO and other C-level executives are buying shares in their own companies, it’s usually because they know something that normal investors do not. Insiders buying stock regularly show investors that managers are willing to put their money where their mouths are. Peter Lynch, one of my favourite investment guru summed it up best in his quote below.
“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” – Peter Lynch
Where can I find information on insider trading? As insiders are required by law to declare their trades whenever they buy/sell their company’s shares, you can find it from the filings made to their respective exchanges. Read the historical filings and look for insider activity.
3. Compensation Packages
The management team of a company should be rewarded accordingly based on the business performance and how they increase shareholder value. But knowing how much the management should be compensated can be tricky to determine. It usually differs from industry to industry. What I don’t like to see is when management starts to abuse their power and overpay themselves. My “radar will be up” when I see management making an obscene amount of money while the company continues to lose money and underperform.
Stock options or restricted stocks are a great way to remunerate the management as they see themselves having ownership of the company and are more likely to work harder and generate better results. It’s true that options tie compensation to performance, but not necessarily for the benefit of long-term investors. Sometimes, the fear is when management cook up the books to drive the share price high and make use of their stock options to make a quick buck for themselves. Also, stock options aren’t free, so the money has to come from somewhere, usually the dilution of existing shareholder’s stock.
As with stock ownership, I will see whether management is using options as a way to get rich or if it is actually tied to increasing value over the long run. You can sometimes find this in the notes to the financial statements.
4. Related Party Transaction
Related party transactions happen when a listed company has business dealings with another company that is related to the founder or a board member. As an investor, you have to assess the transaction and deduce whether it is done in alignment with shareholders or if a large amount of money is flowing out of the listed company to a related private company. I will be very wary if I see management using his other companies as a front to siphon money out of the listed company into the private companies they own.
At Journey With Money, we practise the principles of Value Investing. We welcome comments below so we can improve the quality of our articles.