An Analysis Of Corporate Management
Quarantine Log Day 13(?): Time really is a flat circle.
A few years ago I started writing a more advanced version of the Learn App that included some practical tips and tricks that we use when analyzing companies. It never really felt like Learn was the appropriate medium for it though. So, in order to mix things up over the next few weeks and try to get some escape from the constant CV-19 news, I thought I’d try to repurpose them for the Daily Insight. Let me know what you think.
"Invest in businesses any idiot could run because someday one will." - Peter Lynch
It would be great to find such businesses. However, in my experience, they are few and far between. When we analyze businesses here, we always put a huge amount of effort into looking at management and plenty of companies have not made it into MyWallSt because the leaders of the business did not stack up.
When investing, it’s important to imagine your money being put to work. Let’s say I have $5,000 and I’m looking to invest. I’m betting that the managers of the business I invest in are going to use that money better than I am. (That’s not entirely how it works, but it’s a good way of thinking about it). Now, that $5,000 may not mean a lot to the CEO of a Fortune 500 company, but it means an awful lot to me. Therefore, I want to make sure that that CEO is going to be a good steward of my money.
So how do we go about assessing that?
From a purely quantitative standpoint, you can look at things like return on capital — for every dollar that goes into the business, how much money is being generated? That’s a good sign that management is effective capital-allocators, and that money is not being wasted.
You can also look back on how management has spent funds in the past. Have they acquired any companies? If so, did they pay a reasonable amount and did the acquisition work out well? Prudent capital allocation is one of the best signs that you’re dealing with top-class management and that CEOs are not just having fun with the company’s coffers.
Past stock-price appreciation is also a good metric. I know it’s hard to look at a stock sitting at its all-time-highs and think that you should be investing. However, there are some businesses like MasterCard, Home Depot, and Salesforce, that are pretty much always at their all-time-highs. This is down to incredibly talented managers that build their businesses for long-term, steady growth. They don’t over-extend the company with wildly ambitious growth plans or run up large debt to fund acquisitions. They’re measured and reasonable.
But both these methods only look at what’s happened in the past. As we all know, the stock market is only concerned with what’s going to happen in the future. So how do we assess how a manager will perform going forward?
This is where it becomes a lot more instinctual.
You should try to get an overall sense of the person in question. If the CEO is also the founder, it’s great to dig into the story of how they started the business — what obstacles they faced and how they overcame them. There’s usually profiles of successful entrepreneurs published in the likes of Forbes and Fortune magazine.
If the CEO is not the founder, you can get a good grasp of their past experience by checking out their LinkedIn page. You’ll notice a lot of CEOs come from vice president positions in big companies like PepsiCo and Ford. These are positions usually reserved for high achievers, so it’s always a good sign to see on a resume.
Glassdoor is one of our more recent tools for assessing business leaders and is a brilliant resource for finding out what the staff thinks of their boss. Great CEOs inspire their workforce and when a company is doing well it creates a good working atmosphere.
Interestingly, if you check out Glassdoor's top-rated CEOs, you’ll find many of the companies we recommend in our shortlist.
You should try to watch or read interviews with the person in question. You’ll find plenty of footage online of the likes of Warren Buffett, Elon Musk and Satya Nadella. For smaller companies, this may prove more difficult, but you can always listen in on one of their quarterly earnings calls. These are a great way to gauge how well a CEO knows his business and how well he responds to tough questions from analysts.
When assessing a CEO’s character, you should be asking yourself whether this person seems competent and suited to the role. I always like to see that a CEO has a long-term vision for the company and that his actions are aligned with that vision.
Finally, you want someone who seems honest and has a lot of integrity. Remember, it’s your money you’re trusting this person with. Managers that speak candidly and admit their mistakes rather than passing the buck are always a welcome sign when it comes to investing.
If you’re able to put your trust in a good CEO, you’ll be far better equipped to ride out any downturns and benefit from the upside of long-term buy-and-hold investing.