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Should You Care About The People Running These Businesses? |
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Finding a great business is one thing, but just how much weight should one give to the quality of management? Warren Buffett certainly attaches a lot of importance to it. But how do you gauge management quality? After all it is not objective in the sense that no number can be attached to it. According to Buffett, there are three ways in which management quality can be judged. One is by looking at the past performance of companies. Why is that? Past performance is highly indicative of how well the management has been able to steer the growth of the company. This is through both good times and bad. Indeed, a good management needs to be proactive and should have the ability to respond to changes, competition, opportunities and threats. Having said that, what needs to be noted is that the management track record has to be evaluated in context of the sector dynamics in which companies operate. For instance, it would not be fair to compare Infosys' management with that of Bharat Petroleum Corporation Limited (BPCL), as the oil and gas sector is highly regulated, whereas the software sector is not. The second is by judging how well the management treats its shareholders. Shareholders obviously stand to benefit if the management has been able to provide healthy returns on capital and dividends on a consistent basis. Return on invested capital and dividend yield are some of the important parameters to be looked at while determining whether a shareholder is getting the most of what he has put into the company. How effectively the management is able to allocate capital is a very good indicator of its quality. For instance, one needs to evaluate whether this capital is being invested in projects or activities in line with the company's overall growth strategy. Moreover, are these investments generating good returns? If the capital is not being invested, then whether the same is being distributed to the shareholders. Let us take the example of Hindustan Unilever. We had recommended this stock for our first portfolio in May 2010. At the time, the company has been consistently generating returns on equity well above 35% in the last 13 years with a fantastic track record of paying handsome dividend to its shareholders. And we were not disappointed. From the time we came out with the recommendation till the time we exited from the stock in July 2013, the stock delivered returns in excess of 100%.
That is why management quality is a crucial factor according to us. It becomes important to have a grasp on the people at the helm of affairs before taking the decision to invest in the stock of a particular company. So to sum up, the first two points that you need to consider while investing is the moat that a company enjoys and its quality of management. But there is still that third important element that you need to consider before finally taking the plunge and buying a stock. Do look out for my last email where I will talk more about this. But before that, I would like to inform you that there is a chance for you to invest like the legendary investor himself and build a very profitable stock portfolio. To know more about this, please click here. » Next: Is This The Right Time To Buy The Stock? |
