When evaluating a company’s management, there are several factors to consider.

The majority of investors recognize that a company’s management team is critical to the success of the company. The problem is that evaluating management is a challenging task. There are so many intangible aspects to the job that we cannot see. It is clear that investors cannot always be confident in a company based solely on the financial statements that are provided. Fallouts from companies such as Enron, Worldcom, and Imclone have demonstrated the importance of emphasizing the qualitative aspects of a company’s operations and operations management.

The Most Important Takeaways

  • Even though there is no magic formula for evaluating management, there are some aspects to which you should pay particular attention. In this article, we’ll go over a few of these warning signs.
  • Understanding the quality and skill of a company’s management is critical when evaluating an equity investment because it is the only way to accurately predict the company’s future success and profitability.
  • Looking solely at the stock price, on the other hand, can result in false signals. In fact, several high-flying companies, such as Enron and Worldcom, have seen their stock prices soar despite the fact that their management teams were corrupt and incompetent.
  • In order to determine how well management is performing, look at indirect metrics such as the length of time the managers have worked there and the type of compensation they receive, as well as factors such as stock buybacks.

Management’s Responsibilities

Any successful company is built on the strength of its management team. Employees are also very important, but in the end, it is management that makes the strategic decisions that are most significant. Management can be compared to a ship’s captain in terms of responsibility. Managers do not typically drive the boat, but they do direct others to ensure that all of the factors that contribute to a safe trip are taken into consideration.

It is theoretically the responsibility of the management of a publicly traded company to increase the value of the company for its shareholders. In order to effectively run a company in the best interests of the owners, management must possess sound business acumen. Of course, it is unrealistic to believe that management is solely concerned with the interests of the stockholders. Managers are people, too, and they seek personal gain in the same way that everyone else does.

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The situation becomes problematic when the interests of managers diverge from those of the shareholders, as in this case. The theory that underpins the likelihood of this occurring is known as agency theory. It asserts that unless the compensation of management is linked in some way to the interests of shareholders, a conflict will arise. You shouldn’t be under the impression that the board of directors will always come to the rescue of the shareholders. Management must have a legitimate reason to be in the best interests of shareholders.

The stock price does not always reflect the quality of management.

Some argue that qualitative factors are superfluous because the true value of management will be reflected in the company’s bottom line and stock price, rather than qualitative factors. Over the long term, there is some truth to this, but a strong performance in the short term does not imply sound management.

The dotcom bubble burst was the most dramatic example. The new entrepreneurs were expected to change the rules of business for a period of time, and everyone speculated about how this would happen. The stock price was considered to be a reliable indicator of future success. In the short term, the market, on the other hand, behaves strangely. Strong stock performance alone does not imply that the company’s management is of high caliber, as some believe.

the duration of one’s employment

One good indicator is the length of time the CEO and other members of top management have been with the company. The former chief executive officer of General Electric, Jack Welch, worked there for approximately 20 years before he decided to leave the company. Many consider him to be one of the greatest managers the world has ever known.

Warren Buffett has also spoken about Berkshire Hathaway’s outstanding track record of retaining top management. When making investments, Buffett looks for companies with solid, stable management that is committed to the long term success of their organizations.

Strategy and Objectives

Consider the following question: What kinds of objectives has the company’s management set for itself? Is there a mission statement for the organization? In what ways is the mission statement succinct? Incorporating a mission statement into a business plan helps to set goals for management, employees, stockholders, and even partners. When a company’s mission statement is stuffed with the latest buzzwords and corporate jargon, it’s a bad sign.

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Insider Buying and Stock Buybacks are two types of stock buybacks.

In most cases, when insiders buy shares in their own companies, it is because they have access to information that ordinary investors do not have access to. Regular purchases of stock by insiders demonstrate to investors that management is willing to put their money where their mouths are. Keeping track of how long management has held onto its stock is critical in this situation. A quick buck can be made by flipping shares, but investing for the long term requires a different mindset.

In the case of share buybacks, the same can be said. You will almost certainly hear from the management team of a company that a buyback is the logical use of the company’s resources when you inquire about buybacks. After all, the goal of a company’s management is to maximize the return on its shareholders’ capital investments. If a company is truly undervalued, a buyback can increase shareholder value significantly.

Compensation

High-level executives earn six- or seven-figure salaries per year, and with good reason. Good management pays for itself over and over again by increasing the value of the company’s stock. However, determining what level of compensation is excessive can be difficult to determine.

Something to keep in mind is that management in different industries receives different amounts of compensation. Typical CEO compensation in the banking industry is more than $20 million per year, whereas the average compensation in retail or food service companies is less than $1 million per year. As a general rule, you want to make sure that CEOs in similar industries receive compensation that is comparable to their peers.

If a manager earns an obscene amount of money while the company suffers, you have reason to be wary of that individual. If a manager truly cares about the long-term interests of the company’s shareholders, would that manager be willing to pay himself or herself exorbitant sums of money during difficult times? It all boils down to a problem with the agency. What incentive does a CEO have to do a good job if he or she is earning millions of dollars while the company is on the verge of going bankrupt?

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It’s impossible to talk about compensation without bringing up the subject of stock options. When options were first introduced a few years ago, many hailed them as the solution to ensuring that management increased shareholder value. The theory sounds good on paper, but it doesn’t hold up in practice. Optional compensation is tied to performance, which is true, but it is not always in the best interests of long-term investors.

In order to make a quick buck, many executives simply did whatever it took to drive the stock price higher so that they could vest their options. When investors realized that the books had been manipulated, stock prices plummeted once more, while management pocketed millions of dollars. Also, stock options aren’t free, so the money to pay for them has to come from somewhere, which is typically the dilution of existing shareholders’ stock.

In the same way that stock ownership should be scrutinized, options should be scrutinized to determine whether management is using options as a means of getting rich or whether they are actually tied to increasing value over time. This information can be found in the notes to the financial statements on occasion.

If you don’t have one, search for a Form 14A in the EDGAR database. A number of factors will be included in the 14A, including background information on the managers, their compensation (including option grants), and inside ownership information.

What’s the bottom line?

Despite the fact that there is no single template for evaluating a company’s management, we hope that the topics we’ve covered in this article have provided you with some ideas for evaluating your own organization.

Each quarter’s financial results are important, but they don’t tell the whole story because they are only a snapshot. Spend a little time looking into the people who are responsible for filling in the numbers on those financial statements.

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