Analysis of Management : Key Questions to Ask

--- tags: dd --- # Analysis of Management : Key Questions to Ask ### Introduction :maple_leaf: Value of a stock is market's perception of the company. A company is not just collection of bunch of metrics and data presented in annual reports or disclosures. _Management_ is the group of people, who give direction to the business. It's of paramount importance to form a view of the people who are designated as management and responsible for its vision & mission, if you're deriving fair value of this stock. --- ### Who's in Management? ## The role of management in a company A typical management team of a company includes, - Chief Executive Officer (CEO), who is often the Managing Director (MD), in charge of overseeing core operations, planning strategies and policies, supervising other executive officers, and taking managerial decisions for the company. - Chief Financial Officer (CFO), in charge of planning and managing financial activities for the company. - Chief Operating Officer (COO), in charge of overseeing operational activities for the company. - Chief Technology Officer (CTO), acting as a bridge between engineering and business functions of a company, in charge of making executive decisions with regards to the technological aspects (such as company's technological vision, strategies, and ensuring that these decisions are aligned with the company's business needs) - Full-time directors, collectively referred to as the Board of Directors representing the shareholders, responsible for making and managing long term strategies/policies for the company - Company secretaries, in charge of ensuring the company's compliance with various legal obligations and regulations. - Employees no more than one level below the board of directors and are designated as key managerial personnel by the Board.[^1] - Other officers as defined by the Articles of Association of the company in line with SEBI rules & Company Act, 2013[^1]. The responsibilities of a CEO and MD, the most important positions in management of a company, are often confused with one another. As a matter of fact, the roles and duties of the either positions are very similar, and both the positions report to the Board of Directors. The prime differences between a CEO and a MD are, - The Chief Executive Officer (CEO) is a senior executive of the management who takes managerial decisions and guides executive officers on activities related to the company. - The Managing Director (MD) is a senior member of the Board of Directors (third only to the Chairman & Vice-Chairman) who manages day to day operations of the company and helps the board to formulate strategies and policies. Apart from the Board of Directors (BoD) and Key Management Personnel, companies in India also have the notion of promoter (groups). While the promoters of a company are technically not *managers*, we have covered their evaluation as part of this section for simplicity. According to Section 2 (69) of Companies Act[^2], the term *promoters* refers to a person or a group who, - who has been recognized as such in a company's prospectus or annual return[^3], or - **who has control over a company's affairs**, or - who the Board of Directors have considered to seek advice, directions and instructions from *(provided that the person / group isn't merely acting in a professional capacity)* For example, the Ambani family are promoters of Reliance Industries, Tata Sons, a private company, is the promoter of Tata group companies such as TCS, and Unilever plc, a British MNC, is the promoter of FMCG giant Hindustan Unilever. ## Analysis of managers, board of directors & promoters Now that we know the different people involved in managing a business, we can start with evaluating a company based on actions of these various groups. You may wonder if there's any point in this whole exercise assuming perhaps there are better indicators of a company's prospects, such as its financials. The intent behind doing a complete due-diligence is to factor in all variables that can affect the market value of a company. Warren Buffett, one of the most successful investors of all-time, frequently mentions a mental checklist to evaluate a company's management, and concedes on placing a high premium on management integrity before making a purchase decision. > I want a business with a moat around it. I want a very valuable castle in the middle and then **I want the Duke who is in charge of that castle to be very honest and hard working and able**. Buffett's checklist originally comes from Philip A Fisher, another well-known investor, known for his book [*Common Stocks and Uncommon Profits*](https://www.amazon.in/Common-Stocks-Uncommon-Profits-Writings/dp/8126528613) based on Growth Investing. In his book, Fisher talks about 15 points to look for before investing in a stock, which can be helpful to evaluate a company's management. These checklists are provided [here](https://economictimes.indiatimes.com/markets/stocks/news/fishers-15-point-checklist-to-select-quality-stocks-that-can-deliver-big/articleshow/79693854.cms) and [here](https://www.oldschoolvalue.com/investing-strategy/common-stock-checklist/) and are used below to highlight some examples but readers are encouraged to buy the book for personal reference. --- * Does the management have the determination to continue development of products and processes to increase total sales when the existing growth potential has been exhausted? Fisher was suggesting that investors look for companies that have excellent management and are willing to continuously develop products & processes even after the growth potential has stopped due to market maturity. A company needs to develop new products to expand into existing markets or create/enter new ones, which is not possible without an excellent management team. A company which failed because management did not realize the technology and innovations it had, was Eastman Kodak. A generation ago, a “Kodak moment” meant something that was worth saving and savoring from the numerous TV and print ads but Kodak was so blinded by its success in the physical film space that it did not spot and do something about the first digital prototype for a digital camera by its own engineer, Steve Sasson, who developed it in 1975. The company filed for bankruptcy protection in 2012, exited legacy businesses, sold its patents before re-emerging as a smaller company in 2013. Sasson told [The New York Times](http://www.nytimes.com/2008/05/02/technology/02kodak.html) in an interview that management’s response to his idea was “***that’s cute – but don’t tell anyone about it.***” Conversely, a company that succeeded was Apple, whose executive team member, Jon Rubenstein, was travelling to meet Toshiba in Japan on another collaboration when they showed him a prototype of a small portable hard drive. He took it back and showed to Steve Jobs, who decided to use it to launch the iPod that put a "1000 songs in one's pocket". * Does the company have an above average sales team? This point indicates that a company's survival is dependent on sales in a highly competitive environment and it highlights the importance that a good sales team can easily sell a company's products that are so attractive in demand and compelling to customers that they continue to sell more in the future, even if they are handful in numbers. An example in the Indian context is Fevicol from Pidilite Industries or Parachute Coconut Oil from Marico. These names are synonymous with the product that people instantly recognize them. However, the companies have an outstanding research, production and sales teams that they continue to make steady sales and have been an above-average compounder for investors, who have been holding the stock for years. The above failure of Kodak was not the only one as it also purchased the first digital photo-sharing site, Ofoto, in 2001 but didnt understand digital well-enough that they used Ofoto to try to get people to print digital images. It eventually sold the site to Shutterfly as part of its bankruptcy plan for less than $25 million in April 2012. And coincidentally, in that same month Facebook purchased Instagram for $1 billion. Fisher also pointed out other questions, which are part management and part business & product but holistically, serve to answer the question to the investor on whether it is worth putting one's money into the stock. Some samples of these questions are: * Does the company have outstanding labour and personnel relations? This is critical to look in terms of management relationship and attitude towards employees, which may cause strikes, turnover and higher expenses for bad management and a happy, well-performing and healthy relationship for good management. Maruti Suzuki had a lock-out at its Manesar plant near New Delhi where workers staged a series of strikes and plant occupations from June 2011 to July 2012. The primary issue were the classification and designation of workers/apprentices/trainees, who were paid differently and the lack of sufficient overtime pay. The incident escalated till a Workers Union was formed and recognized by the state and company but also resulted in continued tensions to this day between the union and management even though both parties have agreed to cooperate with each other. * Does the company exhibit depth in its management? Is there a proper succession plan in place for key positions of the company? Fisher emphasized that companies should be avoided if top management was reluctant to delegate authority and decision-making to lower-level managers. He believed that it was vital for a company to succeed if it had a deep pool of management talent that could fill the voids left by leaders and replace talent with them if key leaders left the organization. A recent example was when Shashidhar Jagadeesan took over from Aditya Puri as head of HDFC Bank when he retired from his post in 2020. Shashidhar had been attending the company quarterly con-calls for quite some time and was already introduced to the analysts during his 20 year stint as Aditya Puri's right-hand man. Additionally, Aditya Puri had hinted during many calls that his successor was home-grown and was capable of handling the pressures of the top job and was considered the best candidate in his opinion. So it didnt come as a surprise to people (but analysts were surprised), who had been following the company news and was aware that the successor was an internal candidate well-recognized by management and considered to be the best of the people they interviewed for the job. * Is the management candid with shareholders during good and bad news? It is important for investors to seek companies with management that reports honestly to shareholders on both good and bad aspects of the business. While every business has its own ups and downs every quarter, it is important for management to be candid and hiding facts during bad times indicates a lack of accountability towards its shareholders. An example to this is the management of RBL Bank, which has been very candid in sharing details of its NPAs on its books and the stress that is causing on the balance sheet. Additionally, the company Managing Director and Chief Executive Officer Vishwavir Ahuja has clearly articulated on the expected growth and when the NPAs would be off the books to ensure profitable growth for the bank. * Does the company have a management of unquestionable integrity? Fisher's broader points was that investors should pick such companies for investment, whose management have shown and continue to show a strong sense of trusteeship and moral responsibility to their shareholders. Apart from the above questions, Warren and other investors such as Charlie Munger, Michael Shearn, Mohnish Pabrai amongst many others have built some more questions to this list, which are added below. * Is management rational? Are they competent enough to run it? * Has the management demonstrated a high degree of energy? * Has management resisted the temptation to grow quickly by merger? (e.g. see the [GMM Pfaudler takeover of its parent in Aug 2020 and the subsequent Offer For Sale (OFS) announcement that riled up investors due to the low float before the OFS and the expectation of increased free float after the OFS](https://trendlyne.com/posts/2592783/gmm-pfaudler-it-started-with-an-acquisition-then-things-fell-apart)) * Has management the strength not to follow the institutional imperatives (avoid following current business and sector fads)? * Has the business been free of a major merger in the last 3 years (as mergers have had some failures)? See an [example of how the AOL-Time Warner merger](https://www.nytimes.com/2010/01/11/business/media/11merger.html) went wrong * Are stock options tied to short/medium-term performance rather organisation’s performance? (e.g. [the fight between Narayana Murthy and the board of Infosys regarding the compensation and severance packages to senior executives even as layoffs were happening](https://www.business-standard.com/content/b2b-manufacturing-industry/executive-compensation-in-india-summing-up-the-infosys-controversy-117060900746_1.html) * Is the management style overly conservative or aggressive? * Have the actions of the promoters or managers been in the interest of minority/retail shareholders? * Have the promoters or managers been transparent & integrous in actions that impact the operations or valuations of the company? * Is the management of the company being remunerated more than they should be? * Do the promoters or managers of the company communicate well with the shareholders (hold conference calls, conduct interviews, answer to investor relation emails, etc)? * What has been the trend for promoter shareholding in the recent past? * Is the quantum of shares pledged a concern? * Are there too many/suspicious related party transactions taking place? * Are there any red flags in the auditor notes, or any accounting shenanigans? From the above questions, one can see that there is no magic formula to pick quality company stocks with good management directly but one can use the above checklist as a starting point to conduct in-depth research on the quality of a management that runs a company. --- [^1]: http://ebook.mca.gov.in/default.aspx [^2]: http://ebook.mca.gov.in/Actpagedisplay.aspx?PAGENAME=17381 [^3]: http://ebook.mca.gov.in/Actpagedisplay.aspx?PAGENAME=17475