Understanding and analysing the actions of a company's management is a precursor to sound equity investment
Realms of paper, hours of broadcast and gigabytes of information are released everyday on various companies and whether they make for a good investment or not. Sure enough, each company has its own intricacies. But if there is one advice that every investment expert will vouch for, it is that investors should look at the quality of the management. That's easily said though. How and where does one begin checking the quality of management?
Experts suggest using a mix of qualitative and quantitative parameters to judge a company's management. So, here we look at how you can understand these factors before making an investment.
QUALITATIVE ASPECT
If a family's financial assessment begins with how effectively they use their monthly income, why should it be different for companies? Ravi Gopalakrishnan, head, equities, Canara Robeco Mutual Fund, looks at how well the management used capital. He says, "The ability of the management to deploy capital efficiently based on past track record needs to be evaluated. Raising capital periodically from the market or unrelated capital expenditure for new ventures should raise red flags."
Parag Parikh, director, Parag Parikh Financial Advisory Services (PPFAS) points at other attributes to consider: "We can observe factors like the treatment of minority shareholders," he says. He also advises to check how the management has dealt with acquisitions and try understanding the rationale behind them. "We can monitor management during lean times when the industry is under-performing. That's a good time to separate smart managements from the rest who will take advantage of the lean times to invest in new capacity for expected upturn," he adds.
QUALITATIVE ASPECT
"A company's consistent dividend track record helps us evaluate the ability of the management to reward shareholders," points Gopalakrishnan. "Consistency of returns ratios such as return on equity and assets and return on capital employed compared to industry average across different business cycles also helps us in understanding the efficiency of use of capital by the management", he adds. Meanwhile, Parikh adds that he also looks at working capital related metrics over a period of time, as it shows how the management constantly endeavours to avoid cash drain through good working capital management.
Vivek Mahajan, head, fundamental research, Aditya Birla Money, believes that one can get the historical record of all the key parameters of the company performance during good as well as bad times. "In case management is not able to disclose some data points in view of competition, it is acceptable," he adds.
ANALYSING COMPANY ACTIONS
One of the most difficult parts is to figure out when the management has unintentionally made a mistake, and when they were involved in poor decision making or they are making decisions with malicious intent. The ability of management to identify the needs of the business in terms of capital requirements for new business opportunities or for expansion of existing capacity is an important criterion for evaluation. "Reporting false revenues, excessive related party transactions where the management-owned entities benefit the most, issuing increase in salary despite underperforming business, issuing warrants to key management that allows them to purchase shares at below-quoted market rate, making unnecessary purchases of trophy objects like helicopters/private jets with the company's funds, are ways that harm msinority shareholders," says Parikh. Mahajan adds: "Investors should get cautious when the top management indicates venturing into non-related business from the core business, without proper justification."
Also, while it is not possible for small investors to meet the management, experts point that one should meet the management to understand their intentions. Gopalakrishnan believes that if management is not approachable for small investors, evaluation can be done via channels through which they communicate. Attending annual general meetings, or going through the annual report, will give a perspective about the future course of management's.
Parikh further adds: "If an investor cannot meet the management and yet wants to understand the business & the management quality then he/she should interact with customers of that business, suppliers to that business, to get a good idea about how the management treats these entities. This adds another layer to our understanding about the management."
The original article could be seen here.
