The Practical Way

Thursday, 30th April 2009

How to evaluate the management of a company

Written by George Traganidas Topics: Stock Investing

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One of the most important things to look at before you invest in a company is the quality of the management team. After all, you are buying a part of a company and you want the people who are running it to be of the best quality. Consider four major areas when seeking out top-quality managers.

• Insider ownership. Invest with a CEO who has millions of his own dollars tied up in company stock, and you know he’s going to work awfully hard every day to maximize the value of his shares and yours. Managers with little or no ownership in a company may not care very much about shareholders.
• Service Time. The longer top-level executives have run a company, the better. Almost without exception, true masters in any field have been at it for at least 10 years and practice their craft nearly every day.
• Money Efficiency. When you boil it all down, the main purpose of any business is to turn money into more money in the most efficient way possible. The most reliable clues come from metrics that measure profitability (e.g. net profit margin) and return on investment. The most common of the latter are return on assets, known as ROA, and return on equity, or ROE. Unfortunately, what’s considered a “good” number for any of these metrics varies. Ideally, these metrics would be stable or rising, and they should compare favorably to other companies in the industry. When you compare similar companies, the best allocators are usually the ones with higher margins and returns on investment.
• Ethics. As shareholders, we are part owners of a company, and we want management to treat us accordingly. The management team must be honest, ethical, trustworthy, and transparent. They do not pay themselves exorbitant salaries and bonuses and they do not issue so many stock options that the value of our existing shares is constantly diluted. And they do not set up lavish golden parachutes or adopt “poison pill” provisions that discourage outside buyers who may be interested in acquiring the business.

I hope that this helps you to get a better understanding on how to evaluate a business.

Follow the practical way,
George Traganidas