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:
Let us consider these separately.
- The results of the company
- The treatment of the company's shareholders
- How well it allocates capital
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.
||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.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Jul 25, 2017
One of the nice things about being rich is that you get to observe rich people. Who are they? How did they make their money, you wonder?
Jul 24, 2017
Where does one find value in the stock markets now.
Jul 24, 2017
This despite the fact that interest rates have come down over the last one year.
Jul 24, 2017
Penalties liable under Section 234F of the Income Tax Act, will be applicable from AY2018-19.
More Views on News
Jul 15, 2017
The secret of spotting multibaggers before they become a hit.
Jul 17, 2017
Real estate prices across India have barely gone anywhere over the last four years. Prices have fallen in many cities over the last one-year, new data from the National Housing Bank suggests.
Jul 12, 2017
The most hated sector is offering the best trading opportunity. Are you ready?
Jul 12, 2017
The Income Tax return filing deadline is drawing near; if you have not already filed your taxes, here's how to do it.
Jul 19, 2017
When you're selling an immoveable property, it becomes imperative to recognise the intricate tax implications.
Copyright © 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. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used 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 investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers 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: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407