As a part of a rigorous investment process, it is important to assess management quality before buying shares in a company. There are many ways to research and analyse qualitatively how the management team stacks up. If you are entrusting your capital to a company, it is only fair to know who will lead that company, and whether they are trustworthy and capable of growing your money. Strong management is the backbone of any successful enterprise.

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Why should you assess management quality?

Before investing in a company, it is important to understand who is at the top calling the shots. A lot of investors focus a lot more on the quantitative analysis and fundamentals of a business and do not put much effort into researching management. I kill a lot of ideas during the initial screening and checklist phases because a business usually has poor management which can be reflected in the financial statements and business operations.

The future performance of a business is heavily influenced by the decisions made by the management team. Even the best companies in growing industries with great products can fail if they have an ineffective management team.

It can be difficult to spot management that do not align with shareholder values which can turn into shareholder value destruction. The problem arises when a company poses as a worthwhile investment based on the fundamentals yet becomes hard to assess management quality. You want to understand whether the management can fully deliver to the potential a company may have.

There are a lot of intangible areas that a management job entails. This makes it challenging to evaluate management and whether they are trustworthy or not.

Certain companies, products and services are just structurally more adaptable to growing without the best management running the company. On the reverse, a great management team led by a fanatical leader can catapult a company and create tremendous shareholder value.

So, I believe when you assess management quality it’s best in combination with all the other areas we research. It is not the end all but an important factor to consider.

The two opposing views on assessing management?

There is much debate in the investment world about the impact of quality management on a business. Some investors prefer to focus on trustworthy and capable management, while others prioritize the business itself over the management team.

Pat Dorsey, a well-known investor, has compared companies to horses and management to jockeys. He believes that a good horse is more important than a good jockey, as even the best jockey cannot win a race if they are riding a weak horse.

On the other hand, Warren Buffett has emphasized the importance of selecting “trustworthy and able” management. Peter Lynch, another famous investor, has said that he likes buying companies that can be run by monkeys because eventually, they will be.

Despite the varied opinions on the subject, I believe that the magic happens when a wonderful company is led by an amazing team. Great managers and business models in combination are always better than one in isolation.

I don’t believe that management should be disregarded altogether; it is an important part of due diligence. However, it does not have a major influence on the final investment decision. The purpose of this blog is not to sway anyone’s viewpoint on whether to focus more on quantitative or qualitative factors but rather to emphasize the importance of considering both management and business models when making investment decisions.

Let’s put it this way, I’ve never heard in my 15 years of investing and building companies someone say “I’ll back this product and service and I don’t even care who runs the business”. Everyone wants to know who is at the helm.

Characteristics to look for when you assess management quality.

As an investor, it is important to assess the company management during the investment analysis phase. This can provide valuable insights into the numbers, strategy, and future of the business. Understanding the long-term plan of the business and the milestones required to achieve it is the first step in evaluating the management team. This can help to determine whether the management is aligned, what their strategies are, and how they plan to deliver the plan to shareholders.

Although financial statements and company performance are important, they do not provide a complete picture of the business’s prospects. A poor management team can lead to the downfall of even the most promising company. Therefore, it is crucial to evaluate the honesty, effectiveness, and ability of the management team before investing in a business.

When we refer to the management team we prioritise the Chairman, CEO, CFO and the COO. Having a look at all the executive team can help, however the key decision makers are the focus.

To ensure success, investors should look for a management team that can navigate complexities, deliver shareholder value, operate with efficiency, discern opportunities, and make decisions that will pay off in the long run.

Track Record and Consistency

A track record is a great starting place to assess management quality. Consistency in the business and sustained earnings and returns. What is the team’s past performance in leading a business like this? Are they credible? You can look at the background of the executives, where they come from and how did they get there? How did they navigate any challenges or maximise opportunities? I want to see a track record of reliable, positive, and clear results. It is not too difficult if you are prepared to do your homework. The beauty of the digital age is there are records, especially public companies.

Financial Performance Metrics

The financial metrics are a great indication that the management team is doing the right thing. Consistent and sustainable rises in earnings per share. Profitability, focusing on value creation, not destruction. Not EBITDA and adjustments and clever accounting. A focus on Free Cash Flow and ROIC and ROE or owners’ earnings. The financial metrics that are posted and the metrics the company talk about indicate how they think about a business and shareholder value. Think about Jeff Bezos in Amazon letters. Always referring to the right metrics that create shareholder value as a measure of performance.

Experience and Expertise

This works alongside track record but can also be about expertise, qualifications, and leadership experience. What is their history before managing a company? Did they rise through the ranks or out of nowhere become the CEO of a public company? A lot of investors don’t consider that. Are they even qualified to run a multi-million company? If the company requires specialised expertise, are they familiar and knowledgeable in that sector?

Length of Tenure

Length of tenure is one of the areas I focus on as an initial and quick screen. How long have top management been in place? Long-standing teams are great, they are familiar with the business, understand the ins and outs, committed. If management has been moving around and “shuffling” constantly it is a concern. Perhaps signs of riffing between shareholders or other board members.

A board and team that do not get along can ruin companies as the internal rivalry becomes the focus not the growth of the business of shareholder value. Has the CEO, CFO, or COO changed jobs regularly? If so, then why? Why can they not settle? Companies grow with stability as it takes time for management to execute on a strategy.

Shareholder Alignment and Compensation

Skin in the game. That will tell you how committed a lot of management teams are. Are the remuneration packages high in comparison? Are big bonuses frequent? I want to see stock-based compensation connected to performance over the years not shorter periods, showing some stability. I want to see management with insider ownership, buying on the open market. Are they benefiting themselves over shareholders? If management has little to no shares and huge pay packets, then it becomes a concern. Hired hands rarely achieve outstanding performance.

Capital Allocation

Capital allocation is another huge area of focus. How do management teams allocate the capital of a business? Diligent capital allocation is a sign of great managers. Poor allocation such as diversification outside of component areas can be destructive. Do they return free cash flow to shareholders by either declaring a dividend (ensuring the payout ratio isn’t damaging) or do they buy back shares at reasonable prices and not overvalued which also damages shareholder value? Is ROIC greater than the WACC? Financial discipline is critical. Reinvestment opportunities that create value should be the focus. How have the management team allocated capital in the past and what has been the result?

Corporate Governance and Ethical Conduct

This can be in the form of its ESG policy, governance structure, and adherence to ethical standards. Are the management team dedicated to moral corporate governance? Transparency and accountability are areas to look at. Look for conflicts of interest. Incentives that create moral concerns. Look at the Chairman, the board structure, independent non-executives, and a diversified board are good signs.

Communication and Investor Relations

How management communicates with the stakeholders can reveal a lot about a team. Are they willing to communicate openly to shareholders? Are they responsive to honest tough questions or defensive treating it like it’s their company? Do they reflect a sense of accountability or create a divide between “Management Vs shareholders”? Is the investor relations team easy to correspond with (send them an email and find out)? This can also be about communicating mistakes and errors, honesty and transparency about the company and not sugar-coating anything. If communication is open I always gain confidence.

Employee Relations

Having loyal employees is a fantastic sign of a culture that people want to be a part of. Employee turnover, employee satisfaction, and the reputation of the business as an employer are all key. A company develops a culture from the top down. Employee retention shows that the business has some qualities to it usually the sign of honest and open management. Employees talk, it is not too hard to put the pieces together and discover toxic workplace environments and poor management. Use websites such as Glassdoor, Indeed or Seek and see how the company ranks.

Accounting Irregularities and Changes

Accounting irregularities can be hard to find, but not impossible. Looking for signs of growing revenues and how it converts to cash. A lot of investors focus on the income statement however the cash flow statement is critical. What is converting to cash? Why is revenue high and growing but cash conversion is not? Aggressive accounting is an important area to study (booking revenues ahead of time). I don’t like it when companies change accountants too often or use a smaller, lesser-known firm, it raises alarm bells. You can research fraud, accounting concerns and any past issues that have been flagged. If a company is flagged for these concerns regardless of CEO “awareness” the fish rots from the head first.

Operating Efficiency

Operating efficiency is about how the business uses working capital, focuses on operating leverage, and the frugality of operations. Are they prudent with operating? Big salaries, over capitalised head offices, excessive expenditure on areas of little value add. Not wasting money to “Buy Growth” and not concerned about image but performance. Debt management and leverage are something to watch for. Management teams that don’t take caution about borrowing are not a great sign. Is cash converting? Healthy margins? A focus on improving operating costs and efficiency? I love management teams that are always focused on improvement.

Strategic Vision and Execution

Does the management team have a long-term strategy? Understand the company’s long-term strategic goals and how management expects to get there. Is there a strategic vision laid out and an execution plan? I want to see it translated into actionable steps. Not a “story” of imagination but an actionable plan. A management team with clarity, awareness of the competition, and the trends in the market ahead are good signs. Are they consistent and focused on the same objectives’ year in and year out? I don’t want to see management changing direction all the time. Another sign is constantly revising estimates.

Capital Raising Strategies

Capital-raising strategies can bring together a few of the pointers above however deserve a mention. If a company needs capital, it can get it from 3 places. Using free cash flow, taking on debt, or issuing more shares. I am not a fan of excessive share dilution; it can destroy shareholder value very fast. A conservative approach to raising capital should it need it, is something to observe. Ensuring the company is not taking on expensive debt is a sign the management is aligned with shareholders.

What are the resources used to assess management quality?

As an investor, there are various sources one can use to gather information. Personally, I find the Annual Report to be the most reliable source. In addition to that, I also look at announcements, media articles, research from analysts, and contacts I have within the industry.

I find a lot of value and resources on some private forums and chat rooms where I gather information through “Scuttlebutt”. By doing so, I have found incredibly useful information that has deterred me from investing in certain companies purely because of management issues. It’s hard to hide in today’s world if you are a poor operator, so it’s important to dig deep and you will find what you are looking for.

I also exchange notes with other private investors who often pick up on things that I may miss. Listening to the earnings calls and observing the interaction from management can also provide valuable insights.

The financial reports are also a great place to start. It’s important to understand how the three statements intertwine and what to look out for. Although I am not an accountant, I take an interest in the reporting of a company. I have found all sorts of anomalies in the statements before, such as companies booking early revenues which reveal a significant difference between reported net profit and cash flow.

When evaluating an Annual Report, especially with a long-standing CEO, I recommend going back a few years and finding out the plan and strategy from 5 years ago. Did they deliver on it? What went wrong if anything? It’s important to find the inconsistencies when you assess management quality.

When looking at the Annual Report here are a few areas to observe.

• The salary/remuneration by the management. Rising? Excessive?
• Share dilution whether from a cap raise or SBC.
• Are insiders increasing or decreasing their skin in the game?
• Too many acquisitions that don’t align with core business.
• Debt of the company, rate of interest it pays. Increasing?
• Frequent changes in accounting practices and accountants.
• Is the revenue converting to cash? If not, why?
• Are they executing according to strategy? Investor letter.
• Low-quality accounting and financial reporting?
• How are they disclosing (or not disclosing) key information?

What do I think about assessing management in person?

As a private investor, I don’t prefer meeting management directly to evaluate management quality. I believe there are other ways to assess management quality using qualitative factors. A combination of company fundamentals and deep research can help make more informed decisions. I operate independently and enjoy focusing on my work, research, and analysis without adding another layer of work that requires travel (and putting on enclosed shoes).

Many investors do like to reach out and personally interview management. Perhaps for a fund manager, it is a requirement especially if they are taking large positions in a company. However, there is a rising group of private investors especially in the micro-cap and small-cap space that make it a priority to meet face to face or over the phone to discuss the company and get a feel for the sentiment and behaviour of the CEO.

If you do enjoy this level of involvement and have experience navigating questions, and understanding body language, and the environment, then go ahead. However, if you choose to reach out, make sure you do your homework properly. Don’t be swayed by promotion. Ask for milestones to track performance. You can also ask management what metrics can help you evaluate how things are going.

Another reason why I wanted to elaborate on this topic is to show private investors alternative ways to evaluate management teams without having to fly out and meet them. Not all investors can meet or even want to phone call management. It’s another ball game taking your cue from the management directly.

In Summary…

Understanding the leaders behind the enterprise you want to invest in is simply good practice. A company’s downfall or victory is influenced by the management team’s decisions. A good management team are stewards of OUR capital, and they treat the role with honour and integrity. Greed runs rampant in the markets and especially within heavily incentivised boards and management teams.

A high number of rocks I turn over reveal management teams that do not align with shareholders. Excessive remuneration as a percentage of net profit, public arguments with blatant arrogance, and avoidance of hard questions are all common sightings.

Investors need to look for signs that management is capable and possesses the characteristics that can lead to enduring growth. All investors should seek companies whose management team is committed to creating long-term value for shareholders.

When you assess management quality it sometimes requires outside-of-the-box thinking and research. I do not think prioritising a management team or a business over one or the other. Both collectively working in unison can produce wonderful results.