Often we have heard and read (including on this website) about the necessity of a good and sound company management, which is one of the most important prerequisites before one includes a stock in one's portfolio. But more often than not, this criteria of a good management remains limited to a mere stating of this fact, without any assistance as to how should an investor actually proceed with this valuation parameter (if one can call it) before investing.
The legendary genius and the world's most successful investor, Warren Buffet, also consistently echoes the importance of competent and honest managements in the letters to his shareholders. Some extracts from the same are brought out here.
"Maximizing the results of a wonderful business requires management and focus" (1996). "We feel very comfortable owning interests in businesses...that offer excellent economics combined with shareholder-conscious managements" (1984).
It is a known (and now accepted) fact that it is the good and bad managements that make or mar the fortunes of any company. For a moment, recollect the WorldCom's, the Enron's, the Microsoft's and the GE's of the world and importance of a credible and trustworthy management assumes prime importance. However, it must be noted that evaluating a company's management is never an easy task owing to the various facets with respect to the managements roles and responsibilities, many of which do not have clearly defined boundaries and therefore remain elusive. Further, this exercise of coming to a conclusion with respect to the quality of the management poses even greater problems if the company is a 'new-kid-on-the-block', like the Infosys of the early 1990s.
Below are just a few points, which do not necessarily confirm the quality of management, but nonetheless, would be important to consider:
Management term: The service tenure of the management is a good indication of the management's strength and belief of the shareholders in the same. Among the many examples would be that of Berkshire Hathaway, owned by Warren Buffet, where the current management took the reigns of the company in its hand in 1965 and has since served the company dedicatedly! The top management has to be given time in order to successfully implement its plans that add value only over the long-term. Regular replacement at the top can cast a doubt over the continuance of the plans of the previous management thus adding to the uncertainty.
Management vision: The vision of the management could provide some hint as to the future plans of the company. The goals set by the management, not just for itself but also for its employees, by outlining its strategic goals and broad strategies to achieve the same is a positive sign for shareholders of the company. Also investors could judge the management by continually monitoring the management's progress with regards to its vision statement.
Management track record: Another parameter to judge the management of a company is by delving into its past track record (if existent). This would give a fair idea about how the executives have managed to steer the company in the past, through good times and bad. Of course, a relevant comparison would be only when comparing the management performances of companies in the same sector for various obvious reasons. A good example here would be comparing the consistent performance (with marginal deviations, of course) of an Infosys with the unpredictable performance a Mastek in a volatile software sector.
Management qualification/experience: Considering that the management is the 'captain of the ship' and in order to keep the ship sailing, it is of utmost importance that the captain is well versed with the technicalities of running and managing the ship. Similarly, when the management of a company is either qualified and/or experienced, it is in a better position, owing to its skill sets, to chart out relatively better growth plans for the company. However, though desirable, it must be noted that here we do not mean that it is 'only' the qualified and/or experienced management, which would be able to run a company.
Appropriate use of available resources: It is advisable for the company to use the company's retained earnings to improve the quality of earnings and improve the company's profitability in the future. Otherwise, it is in the best interest of the company and the shareholders that the surplus monies be distributed amongst the shareholders. For example, Hero Honda's strategy of rewarding shareholders with dividends is an indication of the management's shareholder-friendly nature.
Management focus: While one may argue that in today's dynamic, ever changing and globalised world, it would be wise to spread the business groups risk over diverse areas, we believe that too much of a deviation from the core activities and strengths of the management could prove detrimental to shareholder value. The path a company takes should be guided by the vision of the company's management. Any deviation from the same may be detrimental for the shareholders and shareholders need to critically evaluate any diversification plans of the company.
Management competence: The management's ability to react to changes, competition, opportunities and threats and take appropriate actions to correct or take advantage of the same is a good indication of its various capabilities. A pro-active management is definitely a big plus as compared to a passive management. For example, Tata Steel (Tisco) has an upper hand on this parameter as compared to SAIL, which took corrective measures only after having sunk into deep waters and having eroded shareholder wealth considerably.
Management compensation: Since the management comprises of people like us looking after the company for us, they deserve a compensation for the services rendered by them to the company. However, it is the amount of compensation that should be of importance. Top-level executives do deserve handsome pay packages if they continue to deliver time-and-again and through good times and bad. However, obscenely high salaries, and that too when the company fails to sustain its performance over the years, needs to be questioned.
While one has to agree that there is no specific model or pre-defined guidelines as to decide upon management quality, the above should provide some assistance to the evaluation process. So, from next time onwards, don't just restrict yourselves to the analysis of financial results, but try to find out the people who have carved out the numbers. Who knows, you might be in for some surprises!
We conclude here with an extract from a letter (1985) by Warren Buffet to his shareholders, which would sum our efforts in one of the most appropriate way:
"Management cannot determine market prices, although it can, by its disclosures and policies, encourage rational behavior by market participants."