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Investing: Don't forget the management!

Jul 31, 2006

Long-term investing in equities requires sound understanding of the companies, the sector dynamics in which they operate, the past performance and growth prospects and other macro-economic factors such as effect of interest rates and government policies. One other factor, which assumes significant importance, is the 'management'. While company growth can be expressed in numbers, the management aspect is a 'qualitative' factor and cannot be reflected in financial projections. Nevertheless, it is a critical factor that investors cannot afford to ignore. Here, we enumerate the various aspects of the management that investors need to have a fair understanding of: Management vision: The management's vision in anticipating changes in the sector and steering the growth of the company according plays an important role. For instance, given the fact that the pharma industry stresses highly on innovation, both Dr. Reddy's and Ranbaxy realised the importance of R&D and started focusing on the same much before the product patent law. Of course, whether these efforts will yield results is a different issue altogether. Similarly, Ranbaxy was one of the early entrants amongst Indian companies in the US market, based on the management's foresight of the generics potential in the US.

Track record: The financials of a company reflect the management's ability to capitalise on growth opportunities and come out stronger in times of adversities. However, these also have to be evaluated in context of the sector dynamics in which these companies operate. For instance, it would not be fair to compare Infosys' management with that of BPCL, as the oil and gas sector is highly regulated, whereas the software sector is not.

Use of resources: This aspect is reflected in the management's ability to effectively utilise cash. For instance, one needs to evaluate whether the cash is being invested in projects or activities in line with the company's overall growth strategy. If the surplus cash is not being invested, then whether the same is being distributed to the shareholders. For instance, the surplus cash that GSK Pharma received on the sale of its excess properties was returned to the shareholders in the form of share buyback. Similarly, dividend payout record is also a strong indicator of the cash utilisation by the management.

Corporate governance: Ethics and sound corporate governance practices highlight the standards and integrity of the management. This is reflected in terms of disclosures made by companies in its annual reports and its communication with its shareholders.

To sum up...
These are some of the various aspects that investors need to keep in mind. At the end of the day, it is an effective and proactive management strategy that will drive growth of companies, which will ultimately be reflected in the financials and consequently the stock price! Therefore, research the companies well, read the annual reports and keep track of whether the management is on its course to achieve its stated objectives. After all, it is the strong fundamentals of a company that will help investors reap good returns in the long-term.

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