Quality of Management

Posted on 23. Oct, 2010 by TheFreeInvestor in Investing Philosophy

In the previous post, I wrote about five ways to find high quality businesses. There are two more areas that I investigate before investing in a company. This post is about one of those areas – Quality of Management. In my view, when you are a retail investor, assessing the quality of management is probably one of the hardest things to do. As an individual investor, I don’t have access to senior management of the companies that I am researching. However, quality of management is one of the most important factors to evaluate in an investment. If the management is corrupt, the investment is lost from the moment you buy the stock. So, I try to find as much information as I can find about the management from public sources. Here are two things I look for in management:

1. High Inside Ownership

I love companies with high inside ownership. If management has a large stake in the company then I can rest a bit easier that management’s interests are aligned with that of outside investors like me. Of course, the thesis is not true all the time, but it is a positive for the stock. Especially, I like those companies where the founder is still involved in the company. Dolby Laboratories (DLB) is a perfect example of such a company. The company’s founder, Ray Dolby, started the business and still is the chairman of the board. High inside ownership is more relevant to small independent investors compared to large institutional investors who have access to the management. Small independent investors often face the dual issue of lack of time and resources to investigate the background of management teams and small size of investment that makes it difficult to get access to managements. So, investing in companies with high inside ownership takes care of this informational asymmetry to some extent.

2. Experience and Execution Track Record

As I mentioned above, if management is corrupt then the investment is lost right from the beginning. So, it is critical to make sure that the management team is experienced and have a solid execution track record.  However, I must admit that evaluating this criteria for my investments has been difficult. Though lot of information can be found in SEC filings, annual reports, and searching on internet, it is not easy to detect incompetent or corrupt management. One of the blatant cases of fraudulent (or allegedly fraudulent) cases in recent past was the management of Satyam Infotech (SIFY) – apparently the large cash balance on the balance sheet was fictitious !

In case of Satyam, the founders were running the company when the alleged fraud was detected. So, even though investigating the quality of management is important and a critical piece of an investment decision, it is not an easy criteria to evaluate for an outside independent investor. However, as long term investors, it is important for us to keep an eye on the management before and after the investment decision.

Disclosure: As of the publication of this post, I hold long position in DLB. Please read the disclaimer at the bottom of this site.

Tags: DLB, Philosophy, SIFY