When evaluating a company’s management, it is important to take into account how well the company’s leaders manage the company’s business. What a company does with its money is important, but what it does with its people is also important. How it treats its employees and what it does for the community in which it is located are important because these are the people who will run the business and maintain its reputation moving forward.
Every company has a certain way of managing, right? You know: the usual suspects: delegation, power, compensation, autonomy, hierarchy, and a little sunshine and fun. At first glance, these sound like the things that make a company work. But these are just surface-level traits. What really makes a company tick is its management system. Here is a simple but effective model that you can use to grade a company’s management.
When we analyse shares, we usually base ourselves on quantitative data. But everything about the company is unquantifiable. It is impossible to assess the quality of management on the basis of figures alone.
So before you dive into the numbers, it’s a good idea to start your stock research with a simple observation of the company. What should you look for in a company? We can think of a group of people running a business. In everyday language, we call these people the top people in the company.
Why are top managers essential to the business? Because they are the driving force and the decision makers. Without a good management team, it is impossible to lead a company to success.
When a company is run by competent managers, it can go a long way. Even Warren Buffett likes them. Here’s what Buffett says about the importance of quality management.
I think you are judging management on two criteria. One is how they run their business, and I think you can find out a lot about that by reading what they themselves have achieved and what their competitors have achieved, and how they have allocated capital over time.
– Warren Buffett
Contents
Why is quality management crucial?
#9. Book processing
It is virtually impossible for an individual investor to determine whether or not a company’s books are false. Note that a company can manipulate its accounts without crossing the line of legality. External help is therefore necessary.
James Montier’s C-Score can be a useful measure for identifying accounting misconduct. For Indian companies, the C-score is also published. Companies are assessed on nine (9) parameters. If a company receives a score of less than four (4), this indicates manipulation.
Responsibility for handling the company’s financial statements rests directly with management.
Qualitative factors
#1. Management discussion and analysis (MD&A)
The management report is the part of the annual report that is published at the beginning. In this section, management provides its analysis of the company’s performance.
For me, this part of the report is one of my favorites. Some companies make a realistic analysis of their business. But some people are prone to bragging. A simple reading of the board report gives an idea of the state of corporate governance.
The MD&A also allows you to look inside the heads of people like the chairman, CEO, CFO, directors, etc. In this section, the company outlines its goals, plans, CAPEX initiatives, etc.
#2 Related party transactions
This is another part of the annual report that is unavoidable. We’ve heard of people putting company money on the street. They take out a loan on behalf of the company and do not use it for the benefit of the company. They send the money somewhere else.
Generally, the money is redistributed to group companies, promoters, etc. While such transactions are not illegal per se, they may present a conflict of interest. Therefore, companies must disclose all such transactions in the annual report.
Look for companies that are in debt up to their eyeballs. Then open their annual report and go to (Related Party Transactions). In good companies, this area is usually empty.
But suspicious business accounts are proportionately more active here. Transactions such as loans to promoters, directors, group companies are unacceptable. Moreover, this becomes questionable when these loans are granted at low interest rates.
A company can also borrow at high interest rates from its founders or group companies. It’s also a murky business. There are also examples where a company sells its assets at a grossly undervalued price to its founders or to group companies.
The idea is to stay on top of these offers. Consider whether these examples are isolated or recurring.
[P.Note: Dividends paid to promoters and commissions paid to current directors (who are also promoters of the company) are considered legitimate transactions].
#3. Duration of the term of office of the management
The people who run the business come and go. If good managers come in, it’s good for the company and vice versa. But the top management of the company, such as the president, the CEO, the CFO, etc., are the ones who have to make the decisions.
As investors, we would not want to see frequent changes in this group. When a company goes wrong, people change too.
Download the company’s annual reports for the last 10 years. Look who’s at the helm. Also check how long they have been in office. The longer they are on the plate, the better.
For example, if a company changes CEO, CFO, etc. every five years, that’s not a good sign.
Supplement
It is not easy to analyze the quality of management of a company. It can become subjective, and different analysts can see it differently.
This is one of the reasons why I decided to approach this subject in a more analytical way. I try to quantify the parameters by which we can assess management. This reduces the possibility of subjective interpretation.
In my stock analysis worksheet, I tried to include some of these points. Using this, the spreadsheet provides an assessment of the quality of the company’s management.
Some readers sometimes question the evaluation of my management worksheet. This usually happens when they see the poor performance of group companies like Tata.
We often confuse ethics with good work. Ethical management is not always synonymous with good management. Even a few years of good or bad work doesn’t make management great or boring.
I would like to sum up this topic with a very relevant quote from Warren Buffett:
They want to know… how they treat their owners. Read the proxy statements, see what they think – see how they treat themselves and how they treat shareholders. … Bad managers also turn out to be managers who don’t really think about the shareholders. These two elements often go hand in hand.
– Warren Buffett
Frequently Asked Questions
How do you analyze a company’s management?
Analyzing a company’s management is difficult, because it is hard to determine what is a good management and what is a bad management. There are many different ways to analyze a company’s management, but the most common way is to look at the company’s financial statements.
How do you analyze quality management?
Quality management is the process of evaluating quality and the processes by which quality is achieved.
How do you analyze a company?
An analyst analyzes a company by using a variety of methods, including the company’s financial statements, industry trends, and other sources.
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