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Lessons from Philip Fisher VIII - On Managements

Jul 3, 2012

"The extraordinary business does not require good management," says Mr Warren Buffett. "The single most important decision in evaluating a business is pricing power." Buffett made his billions by investing in great product companies such as Coca Cola, Gillette and Kraft Foods. He also bought companies such as railroads and electricity producers whose ability to sustain pricing power depended on a lack of competing options. In his investments he values the ability of the company to raise prices without losing market share to competition. The guru from Omaha states that if you have to have a prayer session before raising prices by 10%, then you've got a terrible business. So, is it fair to state that management is actually irrelevant?

Well, when the weather is conducive and the wind is blowing in the right direction, even a bad captain can steer a ship on the right course. But, when the weather gets stormy and visibility is low, can the same captain deliver results? Well, we think not. A great product company can thrive even under bad management in the short run. But in the long run, a bad manager, like a bad captain can run the steadiest ship aground.

Let's now turn to Phil Fisher and his thoughts on management. The answers to the following questions can help evaluate your investment better on this important checklist.

Does the company have depth to its management?

How many times have we seen newspaper headlines on the search for the next star Indian CEO? One may recall the much publicized hunt for a replacement for Infosys Chairman, Narayana Murthy. The search ended with veteran banker, K.V. Kamath taking the top spot. The year long search for the next Ratan Tata also ended with the relatively unknown Cyrus Mistry expected to take over by December 2012. In contrast a large number of PSUs do not have any formal succession plan in place. Sometimes a few quarters casually pass by without anyone being at the helm.

Succession planning for any organization is important and having depth in management is crucial. Sooner or later a time will come where a company cannot take ahead further growth opportunities without developing executive talent. A few other qualitative aspects within the organization are also important to help develop executive talent. Authority and autonomy to carry out decisions is important. Plus the top management needs to be willing to accept feedback and suggestions from its personnel on how to run the company better, no matter how critical.

Is the management forthcoming when the going is good, but does it 'clam-up' when the going gets tough?

Is the management like a fair-weather friend, who is only willing to share happiness, but not its troubles? It is the very nature of business to go through ups and downs. Even the best run companies go through un-expected difficulties, profit squeezes and a sudden shift in demand. But, is the management forthcoming about its problems? Or does it just avoid the issue? If the management is not communicative, avoid touching the company even with a stick.

3i Infotech is one such example. The company had numerous problems with regards to badly thought out and expensive acquisitions, high debt levels and ratings downgrades. Despite the negative news, the management has decided to take the evasive route and maintain silence. It even discontinued its post result conference calls that it previously used to host every quarter. Several attempts to get a meeting with the management also failed. This put the investor committee on edge, and sent the stock hurtling downwards. All this definitely put a big question mark on the management's ability to run the company.

Does the company have management of unquestionable integrity?

The management of a company is always closer to its assets than a shareholder, says Phil Fisher. Without doing anything illegal unscrupulous, managements can take advantage of their privileged situation at the expense of ordinary shareholders in a number of ways. One way is to pay themselves salaries far above what they deserve for the work performed. Another way is to rent or sell properties that they own to the company at above market rates. Another method to gain wealth is through inside trading, an offence that former McKinsey honcho and Goldman Sachs director, Rajat Gupta was recently convicted for.

There have been numerous cases of such scandals in the Indian corporate landscape. Ramalinga Raju of Satyam Computers, the Rs 8.7 bn scam by Reebok India's MD and COO, etc. Even the recent report on the cartelization by 11 cement companies is also some cause of concern. As they say prevention is the best medicine. The only way to avoid such companies is to invest only in those where the managements have a heightened sense of trusteeship and moral responsibility towards their shareholders. Even if a company may meet all the points on your investment checklist, management integrity is the ultimate litmus test. If it fails, do not take your cheque book out.

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