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February 24, 2016
Five Tips for Evaluating a Management Team before Investing
Examining the strengths of a management team is essential when evaluating your next investment idea. This important step in the research process is often overlooked or not given the proper consideration it deserves. Management quality and character are important and can be difficult to ascertain. However, implosions such as Enron, WorldCom and Tyco emphasize the importance of knowing who is at the helm, what decisions he or she will make and how the culture of the organization will take shape.
Five tips to consider when evaluating management:
- Is executive compensation aligned with shareholder interests? Executives should act as agents in the best interest of the shareholders. In order to ensure this behavior, management teams should be compensated on factors that are important to the investor base and that link pay to long-term performance. However, relying too heavily on one metric (e.g., earnings growth) can lead to risk-seeking behavior that is not in the best interest of shareholders. Ideally, management teams should have meaningful holdings of the company they lead.
- Are there checks and balances in the decision making process? Does the company’s CEO hold multiple titles? This can be a clear signal that one person is making too many decisions with little to no accountability. ISS, a global leader in corporate governance, recommends separating the job of CEO and chairman of the board in an effort to provide reasonable oversight and the checks and balances that maintain an independent board of directors.
- What is the CEO’s track record? A good CEO will have a solid resume with a history of exemplary performance. New CEOs can be just as effective, but increased turnover at the top can be a sign of trouble. It is also important to link the needs of the company with the strengths of the executive. For example, a turnaround specialist may be great to help a company survive a downturn, but not the best visionary for the next level of growth.
- Is there a clearly articulated and attainable strategy? Trying to accomplish too much or too little can often lead to running in place. Check to make sure management has set SMART goals – Specific, Measurable, Attainable, Realistic and Timely – and hold them to it.
- How strong is the management team and next generation leaders? Beware the imperial CEOs who centralize power under themselves. One way to assess this quality is to independently evaluate the quality of each executive and what skills they bring to the team. Another way is to listen to quarterly calls for evidence that the CEO calls out other members of the management team for their solid contributions.
While there is no perfect insight into a management team’s success, these five guidelines can provide a useful framework to avoid the really bad ones. Otherwise, we all can heed Warren Buffett’s advice and, “try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”