X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2015 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
McAfee Secure sites help keep you safe from identity theft, credit card fraud, spyware, spam, viruses and online scams
4 simple steps to Value Investing: Step 3 - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • May 7, 2013

    4 simple steps to Value Investing: Step 3

    In the previous article, we covered the second of the four steps to successful value investing created by the legendary investor Warren Buffett. Let us now move on to the next step in this article.

    A word about management

    Perhaps among various factors that need to be looked at before investing in a company, the management is the most important. But that is also where the difficulty lies. After all, how do you assess management? Unlike company financials, ratios and valuation methods which can we quantified and expressed in numbers, management quality is more subjective. No number can be assigned to it. And yet it is one of the most crucial elements in value investing.

    Buffett's views on management quality

    Legendary investor Warren Buffett also attaches a lot of importance to management quality. He is of the view that there are two main factors in assessing management:

    • The results of the company
    • The treatment of the company's shareholders
    • How well it allocates capital
    Let us consider these separately.

    Results: Past performance is highly indicative of how well the management has been able to steer the growth of the company. This is through both good times and bad. Indeed, a good management needs to be proactive and should have the ability to respond to changes, competition, opportunities and threats. Having said that, what needs to be noted is that the management track record has to be evaluated in context of the sector dynamics in which companies operate. For instance, it would not be fair to compare Infosys' management with that of Bharat Petroleum Corporation Limited (BPCL), as the oil and gas sector is highly regulated, whereas the software sector is not.

    Treatment of shareholders: Shareholders obviously stand to benefit if the management has been able to provide healthy returns on capital and dividends on a consistent basis. Return on invested capital and dividend yield are some of the important parameters to be looked at while determining whether a shareholder is getting the most of what he has put into the company.

    Allocation of capital: How effectively the management is able to allocate capital is a very good indicator of its quality. For instance, one needs to evaluate whether this capital is being invested in projects or activities in line with the company's overall growth strategy. Moreover, are these investments generating good returns? If the capital is not being invested, then whether the same is being distributed to the shareholders. For instance, FMCG companies do not require heavy capex and hence rock solid companies such as Nestle and Hindustan Unilever have not only been generating strong returns on capital but have also been doling out healthy dividends.

    There have been instances in the past where the management of cash rich companies has made ill suited acquisitions which have been a drag on the overall company performance. Instances such as these are examples of misallocation of capital by the management.

    Management strength at the end of the day is a qualitative factor. But investors need to have a grasp on the people at the helm of affairs before they decide to invest in the stock of a particular company. This would mean reading annual reports, analyzing company performance and keeping check on the management's communication with the shareholders. This may not be as concrete as numbers but it certainly helps in forming a reasonable judgement on what the management's objectives are and what it intends to do to drive company performance going forward.

    4 simple steps to Value Investing - Previous article | Next Articles | All Articles
    Try the Warren Buffett Quiz

      Radhika Pandit (Research Analyst), Managing Editor, ValuePro is one of our most senior analysts with nearly a decade-long stint in the field of equity research. She has helped build our pharmaceutical sector research from scratch and has a firm grasp of the Indian automobile industry. Being an ardent follower of Warren Buffett's value investing philosophy, she believes in investing in solid businesses for the long haul.

     

     

     
     
    Equitymaster requests your view! Post a comment on "4 simple steps to Value Investing: Step 3". Click here!
      

     

    More Views on News

    What makes the RBI governor the best of his lot... (The 5 Minute Wrapup)

    Aug 29, 2015

    When most central bankers have become money printers, RBI has been prudent.

    Who's next after 'Great Fall of China'? (The 5 Minute Wrapup)

    Aug 28, 2015

    Proof to discard the decoupling theory and prepare for the next crisis.

    No jobs, no sales: Everything is going wrong with real estate (The Daily Reckoning)

    Aug 28, 2015

    As fewer new homes are being built, the construction industry is feeling the heat.

    No rate increase in September... (The Daily Reckoning)

    Aug 28, 2015

    In fact, the probability of EZ-ier money seems higher...

    When Markets Crash, Cash is King (The 5 Minute Wrapup)

    Aug 27, 2015

    Do you have a cash strategy to take advantage of market crashes?

    More Views on News

    Most Popular

    Markets are crashing. Here's what you should do(The 5 Minute Wrapup)

    Aug 24, 2015

    Between good news and good prices, what should long term investors choose?

    Calculating Price Targets Based On the Head and Shoulder Pattern(Daily Profit Hunter)

    Aug 22, 2015

    Apurva Sheth shows to calculate price targets on the head and shoulder pattern

    No one really knows what's going on!(The Daily Reckoning)

    Aug 21, 2015

    Bill Bonner on why the US 'recovery' is fake.

    Who's afraid of rupee depreciation?(Maverick View)

    Aug 21, 2015

    In this article, Mr Tarapore discusses that why an overvalued rupee is detrimental for the economy.

    India Inc. still waiting for a turn around(Chart Of The Day)

    Aug 17, 2015

    India Inc. yet to witness a change in fortunes. Will Modi Government walk the talk?

    More
    © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Use of the information herein is at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Before acting on any recommendation, investors should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: 91-22-6143 4055. Fax: 91-22-2202 8550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    S&P BSE SENSEX


    Aug 28, 2015 (Close)
    View Detailed Quote

    MARKET STATS

    1. Go