A great management is comprised of intelligent, wise and honest people with good intent who can maximise shareholder value and pass on the benefits rightly due to the shareholders. Management needs to make crucial and correct decisions at different stages of the business life. One of Buffett's investment criteria is to look for solid, stable management that stick with their companies for the long term. Therefore, in order to analyse management, it can be broken into two components, 1. Ability and 2. Intent
SKILL #1: ABILITY
Ability can be reflected in the margins as compared to their peers (reason for differential margin?), changes in ROCE and in their way of handling the various aspects of balance sheet over the long term; Decision making ability – how did the management react under stress situations; We can check how peers are doing in similar businesses – tells about operational capabilities. How has the company performed – sales and profit growth – under the management over a 10-year period? How has the balance sheet been over these years? Successful execution of increase in production capacity especially by green-field/brown-field plants is a good indicator of competent management. It is very good if the capacity addition has been done without facing any delays. Warning signs in promoter/management competence would present in the form of:
» Company abandoned or cancelled its projects in the past
» Company was expelled from projects
» Frequent project execution delays and cost over-runs
The investor should prefer buying shares of companies that are run by managements, which have displayed timely completion of the projects within promised timelines.
Whether the company is paying some dividend - or it is just accumulating cash; What about its capital structure – is it using too much or too less debt; Study the cash flow statement in depth and analyse how the management is utilizing the cash earned in the previous years. Study when and where and for what purpose the cash is being spent on. Will it going to make atleast $1 for every $1 spent? Is management deploying excess cash effectively? Where is the cash generated going? Example of bad use of cash is keeping the money in current a/c.
Talking about dividends: There’s always a limit to which a company can take debt as with increasing debt levels, the lenders would become increasingly worried about the health of the company and in turn, would stop giving further debt to the company. Therefore, such debt funded dividends are not sustainable in the long term and in turn, for a key aspect of management analysis. Investors should not derive any comfort from such debt-funded dividends.
Does the management have the ability and determination to add new products in light of having exploited the market potential of existing products; Is the management able to achieve what it promises or it frequently misses? Check for how the company plans for the future and how their past planning has fared through the years; Check what all the management is doing apart from regular business operations. For ex, is the management focusing on innovation to cater to the changing environment? If yes, are they showing success in the same?
SKILL #2: INTENT
Look at how much salary of top management is fixed/variable. High variable component may make the management decisions myopic; Look for how the management remuneration has grown in conjunction with revenue or net profit growth. If the compensation is increasing faster than the net profit growth or if profits are declining then it is a red sign that the management is not motivated enough to let go money and do what is best for the company. Check if the management compensation too high or too low? Investors should also be very skeptical of warrants/ESOPs issued by the management. They are like free-money or risk free gains being issued at the expense of the shareholders. Investors should always compare the allotment price of warrants with the market price of the shares of the company. Therefore, whenever an investor is analyzing a company and she comes across issuance of warrants to promoters/majority shareholders, then she should analyze the issuance and exercise of these warrants to assess whether the management/promoter/majority shareholders is benefitting at the cost of minority/retail shareholders. Thus, warrant become a key tool for management analysis. Additionally:
» Look at peer salary with similar business size and revenue.
» Look at the median salary multiple of the company.
» Whether ESOPs given are of atleast 3-5 years.
It is essential to search for the name of the company with certain keywords like “Fraud, Issues, SEBI, Dispute, Court etc.” One such search attempt should give an investor about any critical information that might be present in the public domain. The first step to assess the intent of the management is to study the history of management and promoters. History tells by experience if the company is run by genuine players – example, promoters in bogus companies change names every cycle, try to raise capital etc; Fraud managements changing their company names to hide previous reputation; Look at related party transactions and see if money is siphoned off, promoters involved in the same or if transactions are not at arm’s length with sister concerns; Look if promoters have interest in other businesses and how is our company transacting with them – Ex, keeping interest free deposit in loss making company.
The investor should become circumspect when he sees the promoter family members entering into contractual agreements with the company. This is because when two members of the family, like a father-in-law, and a son-in-law sit across the table to decide what percentage of commission would be paid to the company of son-in-law, then the minority shareholder can only pray that they would have her best interest in their mind.
Look if audit & remuneration committee is comprised of only independent directors; Holdings of big institutions – is it decreasing?; Pending cases against the company and promoters; See if auditors/CS/compliance officers are resigning – check the reason for the same; Are they able to confess during difficult times; Tenure of the management - good management is associated for a long time; Check auditor payment detail and if statutory audits differ from internal audits; Levels of pledged shares – high level of pledging is a signal for distress. ( <20% ); Treatment of minority shareholders – diluting equity to fund frivolous expenses or having complex holdings, use of cash in unprofitable manner - expensive buybacks; Do board members bring skill to the board or they are relatives of the founders; Are they adjusting p&l expenses into equity account; Are they trying to smoothen our earnings and try to hide losses using other income?
Start learning about a company’s management by gathering historical and current articles written about the top managers. These articles serve as a trail of evidence as to the past accomplishments of the management team, the type of people they are, and how they have dealt with different types of situations.
1. Company’s sales and profit performance over a period of 10 years
2. Success in expansion plans executed over the years
3. Evolvement of balance sheet structure over the years
4. Use of cash earned over the years (capital allocation)
5. Future plans for growth in light of current market getting saturated
1. Promoters’ background check
2. Percentage change in management compensation compared to profits y-o-y
3. Related party transactions the company is involved in
4. Exercise price and market price of warrants or ESOPs issued
5. Management focused on share price
6. Check for company fraud over the internet
7. Structure of the board and other various committees
8. Tone of the management during difficult times
9. Accounting juggleries that the management is trying to do
10. Tenure of the current management