Company with smart management can grow very smoothly in even hard times also. But if company got terrible management then it is sure that it not going to give extraordinary returns.
Aviation industry in India is best example for it. Interglobe Aviation’s management applied sensible strategies and became leader and consistent value creator in tough industry like aviation. On the other hand Kingfisher Airlines filed for bankruptcy as management was involved in fraud .
So good management with good business is key for above average returns in the market.
To evaluate management is not as easy as evaluating financial position of company as there are not any fixed metrics or sure shot methods of it. It is rather a subjective process.
Intelligent Management Decisions
Strategies and business model is output of management‘s thinking.
If you read annual reports of previous 4-5 years then you can get fair idea of what business strategy it follows and what advantage company get by following it. A person with common business understanding can figure out whether it will work or not.
Also look what kind of results company has given by applying such strategy or if companies are making constant changes in business models. Then it is clear sign that management is failing to take right decisions regarding to business.
Interglobe aviation probably only profit making Indian airline company because it perfectly sensed market preference over cheap fares over than exclusive services. They established perfect niche in that segment anyone who travel via plane could have tell that Interglobe is implementing better strategy over others.
It is ingrained in psychology of humans to work better when proper incentives are there. If management has no stake in company then there is more incentive to reap company by getting more compensation than increase economic profits and create value for shareholders.
Thus it is very important how much skin in the game management has so that they are more inclined to increase market value of shares.
Tough Times Management
What warren trying to say is when there is boom in market all companies perform well. When this boom ends only that time you could know which business are really good.
Recessions in market reveals few things about company. They are robustness in business models and management ability to manage businesses when things are not going as expected. Which will at some period in future also.
Investors always look foe how company have performed in recessions in past and what sensible decisions management have taken to cope up with economic slowdown.
Taking example of Interglobe Aviation again when economy slows all airlines make losses but not Interglobe maintain its ground.
Mergers And Acquisition
This is another event in business which is helpful to evaluate management’s ability of right decision making. Investors should always look how mergers and acquisitions have been worked in past are they proved to be value creator for company or not.
If mergers and acquisitions or foreign subsidiary formations are failing frequently then business may not grow great speed in future or management is failing to make that work.
Creating value for shareholders is prime responsibility of management team. So it is duty of management to take decisions of mergers and acquisition that enhances present shareholders value.
In many cases it has happened that for particular period of time management have taken sensible decisions and then they started taking very lousy decisions. If mergers and acquisitions are failing frequently then it may mean that management has lost their competence.
Mergers and acquisition in same industry with competitors or for backward and forward integrations have worked best in the past.
Very few mergers and acquisitions in completely different industry works because acquire company has very little understanding and experience of economics of acquired businesses.
Beware of acquisitions done just to attain artificial growth at any cost.
Frequent Changes In Board
Board members are the ones who keep watch on management. Major decisions like compensation of management approval of mergers and acquisition is taken by board.
But it has happened in the past that management got excessive power to the extent that management was able to put pressure on the board to remove those directors who oppose CEO’s , CFO’s decisions.
Another possible reasons for resignations is that may be board is aware of any misconduct by management so to get out of the matter they have resigned.
Boards independence is lost in some cases as they get major sitting fees and commissions. Which is major source of income for many directors. Thus they have fear of their removal and they avoid to oppose other directors or management .
For this investor must check educational qualifications experience in their respective fields and total fees paid to directors especially independent directors.
Best way to earn compensations is through ‘Employee Stock Options Plan’ . Because it put very little pressure on profit and loss statement and evaluations of benefits derived from ESOPs cannot be easily evaluated.
Investors should keep eye on how many stock options each person in management team has got, to how much extent it will dilute present shareholders stake and most important whether they deserve whatever compensation they have got .
One ratio can be helpful here management compensations to net profit ratio generally in India. It varies from 10-20% but recommended to compare with other players in an industry.
Percentile Growth of compensations with respect to percentile growth of earnings available to shareholders shall also be tracked.
Management may sometimes make some illogical decision like any kind of related party transactions or any business decisions like changing business model when present one is working fine. Having lot of cash available but still financing loans acquiring loans at rate higher than return on capital employed of company.
It may be because of any kind of vested interest of company for which shareholders of company have to pay hence Warren Buffett have suggested when asked about how to detect fraud. He said there are thousands of companies to invest in if you find suspicious about any company move on to the next .
Management’s Other Interests And Related Parties
Related party transactions are common areas in which fraud are done. It should be always checked whether related party transactions are in interest of the company or both the parties in transactions.
Creating fake subsidiaries or special purpose entities are most common tricks to manipulate entities.
Note : Check whether management owns any business which is directly competing to business as it was found in Kinex fashion brought forward by Amit Mantri.
Although management is factor which is very hard to analyse but it has much importance that it should never be ignored. Reading fraud case studies in the past will be helpful to see management various perspectives.
Investors should think management as suspect of possible frauds to get best out of management evaluation.