How to assess management before buying shares

Management is a key factor in a stock's success. Given the relatively nimble nature of small to mid-cap companies, these businesses are particularly exposed to the positive or negative influence of their management teams' decision-making. Small to mid-cap investors should ensure they are well-informed of management's leadership skills, track record of delivering and performance incentives.

Meet the team

Investors can seek out information about a company's management from a range of sources including company announcements and financial reports, media articles, analyst research and industry contacts. Extremely valuable insights about a company can be gained by face-to-face meetings with its CEO and senior executives, which is why we conduct about 3000 meetings each year.

Meeting competitors, customers and suppliers is just as crucial as it's a useful cross check to what management is telling you. As a general rule, the smaller the company, the greater an investor's access to its senior management team. This is true both for shares in Australia and in global markets.

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Company meetings can provide valuable insights into the motivation of the CEO or management team and allow insight into the strategy set and delivery of targets. They offer the opportunity to gain an immediate and potent impression of the people who run a company.

Observing their body language and overall demeanour can be incredibly insightful. For example, a lack of eye contact or crossed arms may signal that what they are telling us is inconsistent with the reality of the situation. We may meet with the same managers many times over several years. This allows us to develop a rapport with them and understand nuances in their body language, tone and demeanour and, when we detect changes, this can be an important indicator.

Focus on culture

Poor management speaks to the culture of an organisation and there have been a range of studies showing the correlation between corporate culture and financial performance. Examining the corporate culture of a company before investing is essential.

In many cases a company's financial success is largely dependent on the CEO and management team's success in developing and enhancing its culture. Investors can assess the culture of an organisation based on small but insightful details – for example, observing during a site tour whether the manager knows employees by name and how they interact.

I recall one site tour where employees were ducking for cover as the CEO walked investors around the facilities.

Having the ability to admit mistakes and act with integrity in the face of issues can exemplify a strong corporate culture. There are countless examples of companies that are quick to blame external factors like the weather when they deliver poor results but never admit to a tailwind when it works in their favour. Retailers and building material companies are notorious on this front.

A track record of success

While past success is no guarantee of future success, it is a good indicator. This holds true when evaluating a company's CEO and management. In fact, when a board appoints a new CEO with a track record of delivering strong performance, this can be a catalyst for us to invest. In our experience, when a company is underperforming, management can be the most important factor in achieving a turnaround.

The right incentives

The incentive structure of management and whether their interests are aligned with shareholders can often determine if they are making prudent decisions that benefit the company and not just themselves. Ideally, remuneration is a combination of short- and long-term incentives that focus on return on invested capital rather than purely earnings per share (EPS) growth or market share gains.

This ensures that management considers the returns generated on every dollar spent while preventing them from doing dilutive deals that reduce the continuing quality of the business.

Investing together

When a CEO or chairman is a major shareholder in the company you invest in, this can ensure alignment of interests and their long-term commitment to value creation. A metric to consider can be the extent of a CEO or chairman's personal wealth that is tied up in the value of the shares.

Rarely do you see a CEO or chairman with a large part of his or her wealth aligned to a share price adopt value destructive strategies. True founder-led companies can focus on investing and building great businesses for much longer time horizons than your average CEO. Global examples include Amancio Ortega at Inditex, Antti Herlin at Kone in Finland, Phil Knight at Nike, Bernard Arnault at LVMH and Fred Smith at FedEx.

Identifying and backing these types of leaders early has created enormous wealth for their investors. By the same token, management divestments of shares can often be a red flag indicating a lack of long-term commitment to the business and foreshadowing tougher times ahead. 

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