How to assess the quality of a company's leadership.
When you think about investing in a company, it's vital to assess its track record in generating profits, cash and dividends. You also need to look at its financial strength, and to consider the outlook for its markets and its competitive position. But there's another crucial factor that is harder to measure: the quality of its management.
There's no doubt that bad management can ruin a business. The FSA's recently published report into RBS (LSE: RBS) reveals a series of blunders by a highly incentivised management team led by an autocratic and over-optimistic CEO, while the over-large and compliant board had little idea of the risks being run.
On a different level, few investors have been content with the performance of management at Cable and Wireless Worldwide (LSE: CW), which has seen a relentless downward trajectory in its share price in the two years since its demerger. Thankfully, a new CEO has appeared on the scene.
Good management shows itself more subtly. A prime example is Melrose (LSE: MRO), whose track record in buying, transforming and then selling ailing engineering companies speaks for itself. The quality of its management was underlined by the enthusiasm shown for its (ultimately unsuccessful) bid for Charter International (LSE: CHTR) by institutions that had shares in both.
There is no magic bullet when it comes to measuring the quality of a company's management, but it helps to have a disciplined approach. This is my 10-point plan:
1. Check press comment
Reading a few articles about the company can give you some clues how well the management is viewed by the market and/or competitors. For a more incisive perspective, have a look at relevant industry websites.
2. Look at management CVs
In order of importance: the 'big three' of Chairman, CEO and FD, followed by the rest of the board (executive and non-executive) followed by other senior management. What is their track record? Is it with successful or unsuccessful companies? A long tenure with one company is increasingly rare in larger companies, but it can be a sign of strength in smaller companies.
3. Check the board composition
Is it the right size? That's not too large (RBS had 17 directors) or too small. Is there a wide range of skills? Do the non-execs look weighty enough to be an effective check and balance? Are they door-openers, wise counsel or time-serving faded grandees?
4. Is there sufficient financial discipline?
Accountants aren't boring for nothing! Is there a finance director? Does he look sufficiently powerful to be a check on the CEO? Are there any other accountants on the board? Who is head of the audit committee?
5. Check departures and arrivals
Does it look as if rats might be deserting a sinking ship? A departing (or retiring) chairman or CEO might presage a change of direction. On the other hand, poaching from competitors or the recruitment of a 'heavy-hitter' could be a positive sign.
6. Is there a coherent strategy and business model?
Read the annual report to see how the company plans to defend and improve its position in the market, open new markets and turn business into profits and cash. Companies are obliged to describe their strategy and business model in the accounts. If they can't explain it simply enough for anyone to understand, it's probably not a coherent strategy.
7. Look at the company's track record
A track record of increasing dividends and cash flow is probably a more significant indicator of good management than increasing sales and profits. How has the company fared compared to competitors, under its current management? Has its market share increased or decreased? Is it seen as an innovator?
8. Look at directors' holdings
A decent holding of shares is an indicator of confidence and commitment. It's useful to compare the size of a director's holdings with his remuneration -- but check the price shares were bought at. Have they invested a meaningful amount of their own money?
9. Check the reward structure
Does it look over-generous or fair? Is it performance related? How stretching are the directors' targets? Can they earn substantial performance related bonuses by being lucky, or do they have to outperform their competitors?
10. Family matters
Family-run companies frequently do well over long periods of time. Fellow Fool G A Chester has been building a portfolio of family firms. They often have a long-term perspective and are conservatively run with a view to preserving wealth for future generations. Management naturally has very strong loyalty to the firm. But beware of the dangers of nepotism, if companies are forced to recruit managers who are not up to the job.
Judging management quality is less scientific than assessing a set of accounts, but if you look at all these aspects there should be some clues that you can assemble into an overall picture. The bottom line is: do you trust these people with your money?
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More from Tony Reading:
> Tony has shares in Cable & Wireless Worldwide.
